A primer on Consumer Choice Preferences, Indifference Curves and Utility

1. A primer on • Consumer Choice • Preferences, Indifference Curves and Utility Lecture 10

2. INTRODUCTION • Preferences • Indifference Curves • Utility Lecture 10

3. The problem • Simplify the consumer’s choice problem into her making the best she can to maximize her satisfaction Lecture 10

4. Preferences • What is best? • We assume that what is best for the consumer should be left to her to decide (we want to be positive, not normative) • And that her preferences, how much she enjoys the consumption of goods can be described by using indifference maps Lecture 10

5. Preferences • Define a consumption bundle (or basket) as a combination of quantities of different goods (for simplicity 2 goods) • Say we use goods X and Y so the basket is (x,y) Lecture 10

6. Properties of Preferences • We assume preferences to be: • complete: any bundle (x,y) can be compared to any other bundle (x’,y’), the consumer can rank them or know that she is indifferent between both • This might seem rational…but not always, …like when you are 4 years old and your brother is 5 or so :) Lecture 10

7. Properties of Preferences • We assume preferences to be: • transitive: if (x,y) is weakly preferred to (x’,y’) and (x’,y’) is weakly preferred to (x”,y”) then the consumer must weakly prefer (x,y) to (x”,y”) Lecture 10

8. Properties of Preferences • We assume preferences to respect the non-satiation property (for the case of goods) or free disposability Lecture 10

9. Indifferences curves • We can represent the preferences of consumers by using indifference curves • These show in the x, y space those consumption bundles about which the consumer is indifferent • Indifference curve: combinations of goods that give the same level of satisfaction • We are going to think of X and Y as pizzas and burritos and of x and y as pizzas per semester and burritos per semester Lecture 10

10. Indifferences curves Using the property of nonsatiation, we can work out the green area of preferred bundles and the orange area of dominated bundles Lecture 10

11. Indifferences curves The indifference curve passing through e might well look like this (it respects the nonsatiation property) Lecture 10

12. Indifferences curves y The further from the origin, the more utility the indifference curves show Better x Lecture 10

13. Indifferences curves y There is an indifference curve through all possible bundles x Lecture 10

14. Indifferences curves y Indifference curves cannot cross! e b a x Lecture 10

15. Indifferences curves y Indifference curves cannot be any thick! e b x Lecture 10

16. Indifferences curves y Indifference curves for goods should slope downwards e b x Lecture 10

17. Marginal Rate of Substitution y Indifference curves tell us about the willingness of the consumer to substitute one good for the other e b x Lecture 10

18. Marginal Rate of Substitution y The Marginal Rate of Substitution is the maximum amount of one good the consumer is willing to sacrifice to obtain a marginal unit of the other good MRS is the slope of the indifference curve e b x Lecture 10

19. The curvature of indifference curves y Most indifference curves are convex to the origin, exhibiting decreasing MRS between the goods e b x Lecture 10

20. The curvature of indifference curves y But other possibilities exist: concave curves (increasing MRS!!!) => you prefer the extremes to the mixing, perhaps you hate the combination of both goods! Or they are individually addictive… Ice-cream e b anchovies x Lecture 10

21. The curvature of indifference curves y But other possibilities exist: straight lines => what kind of preferences do they represent? e b x Lecture 10

22. The curvature of indifference curves y e Check the slope…constant what does it show? b Go to hidden slide x Lecture 10

23. The curvature of indifference curves y What about this slope? e b Go to hidden slide x Lecture 10

24. The curvature of indifference curves y What about this shape? e b Go to hidden slide x Lecture 10

25. The curvature of indifference curves Sugarcubes These goods have A different complementarily ratio e b Tea cups Lecture 10

26. The curvature of indifference curves y What about this shape? Could happen with food and clothes x Lecture 10

27. Next • Utility and Budget Constraints Lecture 10