1. L02
Preferences

2. Rationality in Economics
Behavioral Postulate: A decisionmaker chooses its most preferred alternative from the set of affordable alternatives.
Budget set = affordable alternatives
To model choice we must have decisionmaker’s preferences.

3. Last Week
oranges
x=(2,3)
p1=2
p2=1
M=6
apples

4. Today: Preferences f ~ f ~
Rational agents: can rank any two consumption bundles
We call such ranking preferences
weak preference: x is at least as good as is y. (x y)
strict preference: x is strictly better than is y. (x y)
indifference: x is exactly as preferred as is y. (x y) ~ f ~ f

5. Rational Decisionmaker
Rationality Axioms (Assumptions) x2
Completeness:
either or or both ~ f
x y
y x
II) Transitivity:
x y and y z x z. ~ f x z ~ f y ~ f ~ f ~ f x1

6. Indifference Curves f ~
Convenient representation of Indifference Curves
The set of all bundles equally preferred to x is the indifference curve containing x;
The collection of all bundles y ~ x. ~ f

7. Representation: Indifference Curves
Indifference curve = a collection of all indifferent bundles. x2
x’ ~ x” ~ x”’ x’ x”
x”’ x1

8. Indifference Curve Mapx2
z x y p p x z y x1

9. Can Two Indifference Curves Intersect?x2 x y z x1

10. Example: Perfect Complements
Two goods always consumed in the same proportion
Example: Right and Left Shoes
We like to have more of them but always in pairs

11. Example 1: Perfect complements
Left
1:1
Right

12. Example: Perfect complements
Coffee
1:2
Sugar (teaspoons)

13. Example: Perfect substitutes
Two goods that are substituted at the constant rate
Example: French and Dutch Cheese
(I like cheese but I cannot distinguish between the two kinds)

14. Example: Perfect substitutes
Dutch
French

15. Slopes of Indifference Curves (MRS)
The slope of an indifference curve is its marginal rate-of-substitution (MRS).
Why rate-of-substitution?
Why marginal?

16. Slope: Marginal Rate of Substitutionx2
MRS(x) is a slope of the indifference curve at x x x1

17. Slope of Indifference Curves
When more of a commodity is always preferred, the commodity is a good.
Two goods. Sign of MRS?
Good 2
Good 1

18. Slope of Indifference Curves
If less of a commodity is prefered the commodity is a bad. (Spinach)
Two goods. Sign of MRS?
Bad 2
Good 1

19. Preferences Exhibiting Satiation
Many commodities become bads after some threshold of consumption
(salt and pepper)
Bundle consisting of threshold quantities
is called a satiation point or a bliss point.
A satiation point is strictly preferred to any other bundle.

20. Preferences Exhibiting Satiation
(pepper) x2
Satiation point
x*2
x*1
x1 (salt)

22. Well-Behaved Preferences
We will typically assume that preferences are well-behaved:
monotonic (all goods)
weakly convex

23. Convexity. Preferences are convex if mixtures “z”
are (weakly) preferred to extremes x and y.
x=(1,3) x2
z =(2,2)
y=(3,1) y2 x1 y1

24. Convex preferences? x2 x2 x1 x1