Principles and Preferences

1. Principles and Preferences • Ch 4

2. Principles of Decision Making • Predicting consumers’ choices. • Why do consumers make different choices? • All are related to Preferences.

3. 1st assumption about consumer behavior:The Ranking Principle: A consumer can rank in order of preferences, all available alternatives. • A consumer is indifferent between 2 alternatives if he likes them both equally.

4. The 2nd assumption: • The Choice Principle: Among all available alternatives, the consumer selects the one that he ranks the highest. • this means that the consumer always attempts to achieve the highest level of satisfaction.

5. Consumer Preferences • Decisions are tend to be interrelated: • the enjoyment of one activity usually depends on other activities. • when spending money on one good, there is less money to spend on other goods.Consumption bundle: a collection of goods an individual consumes over a given period.

6. Ranking Consumption Bundles • Only the consumer who can rank his own consumption bundles. • The 3rd Principle of consumer decision making:The “More preferred to Less” Principle: When one consumption bundle contains more of every good than a second bundle, a consumer prefers the 1st bundle t the 2nd.

7. SOUP X’S ALTERNATIVES AND PREFERENCES 3 2 BREAD 1 0 0 1 2 3 NOTE: 1 IS THE HIGHEST

8. SOUP X’S ALTERNATIVES AND PREFERENCES 3 2 1st BEST? 2nd BEST? LEAST PREFERRED BUNDLE? BREAD 1 0 0 1 2 3

9. SOUP X’S ALTERNATIVES AND PREFERENCES 3 2 BREAD 1 X GENERALLY PREFERS SOUP TO BREAD 0 • MPL??? 0 1 2 3

10. SOUP X’S ALTERNATIVES AND PREFERENCES 3 2 BREAD 1 X GENERALLY PREFERS SOUP TO BREAD 0 0 1 2 3 • IN-TEXT-EXERCISE 4.1

11. Consumer Preferences with Finely Divisible Goods • When consumers can obtain any fraction of a unit (no matter how small). • We use indifference curves (IC) • It shows potential consumption bundles graphically. • each point represents a consumption bundle.

12. Good y IC Good x

13. Start with any alternative and always can find other alternatives that yield same level of utility (U). • IC shows all these alternatives. • How can we identify other consumption bundles that yield same (U)?

14. according to MPL: if we took ∆S, from (A) to (C), the consumer like A at least as well as C Good y D E F A C H G Good x

15. assume you move from C to D, (more of y), compensate by more than ∆S. the cons. is better off than when at (A). to (C), the consumer like A at least as well as C Good y D E F A C H G Good x

16. Good y Since A is at least as well as C, and worse than D: there must be a bundle on line CD that is exactly as good as A which is E. D E ∆B F A C ∆S H G Good x

17. Allocation E lies on same IC running through A. • To reach bundle E from C, we add ∆B of Y. • Thus: Starting from bundle A, adding ∆B of Y compensates the loss of ∆S of X.

18. Good y Since F is at least as well as A, if we move from F to G, which is worse of than A, : there must be a bundle on line FG that is exactly as good as A which is H. D E F A ∆S’ C H ∆B’ G Good x

19. Good y D The line connecting points E and H and other same points is called the IC. E ∆B F A ∆S’ C H G Good x

20. Properties of IC • Since more is preferred to less, 2 bundles cannot be equally attractive unless getting more of another means giving more of the other. • To get more of X, we give up some Y. • If we get more of both, we are better off.

21. Properties of IC • IC are thin. • IC do not slope upward. • Separation

22. Properties of IC FROM A TO B, B HAS MORE OF BOTH THAN A, B MUST BE P TO B, BUT A AND B ARE ON SAME CURVE. THUS, ic CANNOT BE THICK y B IC A IC are thin x

23. Properties of IC y FROM C TO D, D CONTAINS MORE THAN C, D MUST BE P TO C, BUT BOTH ON SAME CURVE! IC D C IC do not slope upward x

24. Properties of IC POINTS TO THE NE ARE BETTER THAN SW BUNDLES. y IC MPL x

25. Families of IC ICs y MPL x

26. Properties of IC y D D, A, AND C ARE INDIFFERENT BUT D AND C LIE ON DIFFERENT IC! IC C A B x