Consumer Choice

Consumption Bundles
We will assume that our typical consumer can purchase from a known set of goods and services. Denote this set by x = (x1,x2,...,xn), where xi  0 for all i=1,...,n. A consumption bundle is then a vector in the non-negative orthant of the n-dimensional real numbers. We will assume for most of the time that any real number quantity can be consumed of any good or service.

! Consumers attempt to maximize their own well-being ! Consumers have good information about all goods they could purchase ! Consumers desire a variety of goods and services

Preferences

Preference Notation

Preferences are the building block or primitive element of consumer choice. We will assume that preferences satisfy a number of assumptions called axioms so that they will exhibit certain properties we consider natural.

Suppose that x and y are two consumption bundles. Then the following notation is used: x y is x is at least as good as y x y is x is preferred to y x~y is x is indifferent to y

Preference Axioms

Reflexivity

! Reflexivity ! Transitivity ! Completeness

Reflexivity means that x~x must be true. This is an axiom that appears to be obvious but is necessary for rational behaviour. What would it imply if it were not true?

Transitivity

Completeness

Transitivity implies if x y and y z then it must be true that x z. This is often the most criticized preference axiom because it implies a considerable amount about rational behaviour.

If x and y are two distinct consumption bundles then either x y or y x must be true. The implication is that a consumer can state a preference relation between any and all bundles.

Indifference Sets

Question

Call the set of bundles that our consumer considers to be indifferent to x, the indifference set to x. {y n|y~x}

Are these preferences sufficient to insure that a typical consumers choice decisions are well-behaved?

Lexicographic peferences
The answer is Suppose we consume two goods, 1 and 2. Let x=(x1,x2) and y=(y1,y2) be two bundles. Then x y if x1>y1 or x1=y1 and x2>y2. These preferences are lexicographic in the sense that preference depends first on the amount of good 1, and good 2 affects the relative ordering of the bundles only if the amounts of good 1 are equal in the two bundles.

NO
Consider the following prefernces called lexicographic preferences.

Question

If a consumer has lexicographic preferences what does his indifference set to x=(2,2) look like?

(2,2)

Implication of lexicographic prefences

Continuity
If x is preferred to y then bundles sufficiently close to x must also be preferred to y. We now have 4 axioms: Reflexivity Transitivity Completeness Continuity

We dont have well-behaved preferences. We need additional axioms.

Major Result

Note

If a consumers preferences over bundles satisfy the four axioms then there exists a utility function u(x) such that: if x y then u(x) > u(y). This utility function will be a continuous function.

We could have started with a utility function as our primitive concept.