Chapter 3

Preferences

Assumptions about Preferences

• Complete--Compare two bundles, A and B. There are three possibilities: A is preferred; B is preferred; they are indifferent

• Reflexive--Any bundle is as good as itself, I.e., A>=A. (note: ”>“ represents “is preferred” and “=“ represents “indifferent”.

• Transitive-- If A>=B and B>=C, then A>=C.

• Strict Convexity (needed only for well-defined preferences)-- If A>=z and B>=z, then a*A+(1-a)*B> z. This assumption is equivalent to a diminishing MRS. The assumption is ad hoc.

03.01

No Crossing Between Two Indifferent Curves

• X is indifferent to Z (X=Z) and Y is indifferent to Z (Y=Z) [Note: = means “indifferent,” not “equal”]

• Hence, X=Y=Z. However, X lies below the steeper indifferent curve, meaning that X is inferior to Y--- a contradiction.

03.02

Some Special Preferences

• Goods are perfect substitutes: U=ax+by [ex: U($1, $10) or U(yellow pencil, red pencil)]

• Goods are perfect complements: U=min[ax, by] [ex: U(coffee, sugar)]

• Y is a neutral good: U=x [ex: U(LeftShoe, .) for person only with the left foot; U(anchovies, pepperoni) ]

• U(good, bad) [ex: U(apple, durian) ]

• Satiated preference

• Discrete goods

03.03

03.04

03.05

03.06

03.07

03.08

03.09

03.10

MRS

• Defined as the rate at which the consumer is willing to substitute one good for the other

• It diminishes as more x is consumed if strict convexity holds.

03.11

03.12

This concludes the Norton Media LibrarySlide Set for Chapter 3

IntermediateMicroeconomics 6th Edition

by

Hal R. Varian

W. W. Norton & CompanyIndependent and Employee-Owned