Consumer Preferences and Indifference Curves: An Introduction - Prof. R. Harrison, Study notes of Agricultural engineering

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Chapter Four

Consumer

Choice

Chapter Outline

1. Preferences.

2. Utility.

3. Budget Constraint.

4. Constrained Consumer Choice.

5. Behavioral Economics.

Properties of Consumer Preferences  (^) Completeness - when facing a choice between any two bundles of goods, a consumer can rank them so that one and only one of the following relationships is true: The consumer prefers the first bundle to the second, prefers the second to the first, or is indifferent between them.

Properties of Consumer Preferences  (^) Transitivity - a consumer’s preferences over bundles is consistent in the sense that, if the consumer weakly prefers Bundle z to Bundle y (likes z at least as much as y ) and weakly prefers Bundle y to Bundle x , the consumer also weakly prefers Bundle z to Bundle x.  (^) Prefers z to y and y to x, then also prefers z to x.

Preference Maps  (^) Indifference curve - the set of all bundles of goods that a consumer views as being equally desirable.

 Indifference map - a complete set of

indifference curves that summarize a

consumer’s tastes or preferences

Figure 4.1 Bundles of Pizzas and Burritos Lisa Might Consume B , Bur ritos per semester (a) 15 25 30 Z, Pizzas per semester 25 20 15 10 5 d a b e c f A B B , Bur ritos per semester (b) 15 25 30 Z, Pizzas per semester 25 20 15 10 a b I 1 e c Which of these two bundles would be preferred by Lisa? Lisa prefers bundle e over bundle d , since e has more of both goods: Pizza and Burritos Lisa prefers bundle e to any bundle in area B Which of these two bundles would be preferred by Lisa? Lisa prefers bundle f over bundle e , since f has more of both goods: Pizza and Burritos Lisa prefers any bundle in area A over e If Lisa is indifferent between bundles e , a , and c ….. we can draw an indifferent curve over those three points

Properties of Indifference Maps

1. Bundles on indifference curves farther from the origin are preferred to those on indifference curves closer to the origin.
2. There is an indifference curve through every possible bundle.
3. Indifference curves cannot cross.
4. Indifference curves slope downward.

Impossible Indifference Curves

 Lisa is indifferent

between e and a , and

also between e and

b …

 so by transitivity she

should also be

indifferent between a

and b …

 but this is impossible,

since b must be

preferred to a given it

has more of both goods.

B , Bur r itos per semester Z, Pizzas per semester I 1 I 0 a b e

Figure 4.2 Impossible Indifference Curves

Solved Problem 4.  (^) Can indifference curves be thick?  (^) Answer:

 Draw an indifference curve that is at least

two bundles thick, and show that a

preference property is violated

Willingness to Substitute Between

Goods

 marginal rate of substitution ( MRS ) - the

maximum amount of one good a consumer will

sacrifice to obtain one more unit of another

good.

 The slope of the indifference curve!

Z

B

MRS

Figure 4.3 (a) MRS along an Indifference curve B , Bur ritos per semester Indifference Curve Convex to the Origin 5 3 8 1

1 1 2 0

• 3 3 4 5 6 Z, Pizzas per semester a b c d I From bundle a to bundle b , Lisa is willing to give up 3 Burritos in exchange for 1 more Pizza… From bundle b to bundle c , Lisa is willing to give up 2 Burritos in exchange for 1 more Pizza… From bundle c to bundle d , Lisa is willing to give up 1 Burritos in exchange for 1 more Pizza…

 The MRS from bundle

a to bundle b is -3.

 (^) This is the same as the slope of the indifference curve between those two points.

 From b to c ,

 MRS = -2.

 (^) This is the same as the slope of the indifference curve between those two points.

Diminishing marginal rate of substitution  (^) The marginal rate of substitution approaches zero as we move down and to the right along an indifference curve.  (^) Discussion: could you imagine a good that does not exhibit this property?

Curvature of Indifference Curves.

 Casual observation suggests that most

people’s indifference curves are convex.

 Exceptions:

 Perfect substitutes - goods that a consumer is

completely indifferent as to which to consume.

 Perfect complements - goods that a consumer is

interested in consuming only in fixed proportions