L7 - Preferences Flashcards
How do individuals behave (in regards to lower prices and higher wages)
Lower price, increases quantity of goods and services demanded
Higher wage, increases quantity of labour supplied
What is the problem behind how we view Individual Behaviour?
It is a assumed relationship
- While it may be correct for some goods, not true for all
What does Consumer Theory examine?
How a person makes sensible decisions under scarcity.
STEP 1: What Individual wants to do
DO THIS BY REPRESENTING BUNDLES OF GOODS (A/B)
STEP 2: What individual can do
STEP 3: The Decision
Why should we have axioms for Consumer Theory?
- Have the simplest possible theory
- Make clear hidden assumptions
- Develop testable predictions
Within the preference of bundles What do we expect of a rational buyer? (AXIOM 1 AND 2)
a) All bundles can be compared
b) All bundles can be ranked consistently
Within the preference of bundles what do we expect of MOST people MOST of the time? (AXIOM 3,4 AND 5)
a) Similar bundles should have similar rankings
b) More is better
c) Averages preferred to extremes
What are the axioms needed for the Preference of Bundles?
Axiom 1: COMPLETENESS (All bundles can be compared)
(For Bundles A and B: Either A is weakly preferred to B or vice versa)
Axiom 2: TRANSIVITY (All bundles can be ranked consistently)
i.e For bundles A,B,C: If A preferred to B and B to preferred to C. Then A preferred to C
IF A1 AND A2 HOLD THEN PREFERENCE ORDER EXISTS
Axiom 3: CONTINUITY (Similar Bundles have similar rankings)
For all bundles A, B and C: If A is strictly preferred to B and B is ‘close’ to C, then A
is (weakly) preferred to C (SEE DIAGRAM)
Axiom 4: MONOTONICITY (More is preferred to less)
For all bundles A and B: If A has more of both goods than B, then A is strictly
preferred to B (SEE DIAGRAM)
Axiom 5; CONVEXITY (Average preferred to extremes) (SEE DIAGRAM)
What is a bundle measured in?
Total Utility
Done in Utils
What is the only thing that matters for Utility
only an ordinal concept (only ranking matters).
E.G: If A yields 80 Utils and B yields 800 Utils
INCORRECT to say B 10 times better than A.
CORRECT to say B is strictly preferred at A
What are Indifference Curves?
They join bundles for which a person receives the same total utility.
Represent Preferences
What are the implications of the axioms to Indifference Curves?
AXIOM 1,2,3: Indifference Curves can be used to represent preferences
AXIOM 4: Indifference Curves downward sloping
AXIOM 5: Indifference Curves have familiar shapes (Indif Curve bowed toward origin and convex to origin)
AXIOM 2: Indifference Curves cannot cross
(SEE DIAGRAMS FOR EACH)
What are the elements of Perfect Substitutes as a special indifference curve?
Perfect substitutes provide exactly the same utility as each other
The indifference curves are straight lines for perfect substitutes (bending downwards)
(SEE DIAGRAM)
What are the elements of Perfect Compliments?
Perfect Complements only provide more utility if used together.
The indifference curves are L shaped for perfect compliments.
What are the ‘bads’ of indifference curves?
‘Bads’ are the opposite of goods: increasing the quantity actually lowers utility.
e.g less pollution being preferred to less
(SEE DIAGRAM)
What is the Bliss Point in Indifference Curves?
A bliss point is a bundle with the maximum possible utility
When little consumed, preferences are well behaved
But consuming more than this point lowers utility.
(SEE DIAGRAM)
