Chapter 2-Rational Choice
under Certainty
A Course in Behavioral Economics by Erik Angner
Instructor: Tolga Yuret
Neo-classical vs. Behavioral
• From now on:
• even number of chapters -> Neo-classical. Reminder for you. We will
skim through
• odd number of chapters -> Behavioral. How previous Neo-classical
theory have changed.
Rational Choice under Certainty
• “under certainty” simply means that there is no doubt as to which
outcome will result from a given act.
• For example, if the staff at your local gelato place is minimally
competent, so that you actually get vanilla every time you order
vanilla and stracciatella every time you order stracciatella, you are
making a choice under certainty.
• Life would be easy if would know dollar exchange rate in the future!
Axioms
• a set of axioms: basic propositions that cannot be proven using the
resources offered by the theory, and which will simply have to be
taken for granted.
Relation
• Small letters to denote entities or individuals. We may use a to
denote Alf and b to denote Betsy.
• Capital letters to denote relations. We may use R to denote the
relation “is older than.”
• aRb for “Alf is older than Betsy.”
• aRb is not the same thing as bRa. The first says that Alf is older than
Betsy and the second that Betsy is older than Alf.
Relation
Exercise 2.1 Relations Assume that f denotes France and n denotes
Norway, and that B means “is bigger than.”
(a) How would you write that France is bigger than Norway?
(b) How would you write that Norway is bigger than France?
(c) How would you write that Norway is bigger than Norway?
Relation
• The universe is the set of all things that can be related to one another.
• Example: U ={Huey, Dewey, Louie}. The order is not important.
Relation
• (weak) preference relation.
• e.g. “coffee is at least as good as tea.”
• c≽t
• For Alf, coffee is at least good as tea
• c≽At
Consumption Bundles
• In economics, we are typically interested in people’s preferences over
consumption bundles, which are collections of goods.
• Two goods in a bundle, we can show it on a graph
• More than two goods: <6, 3, 9> for six apples, three bananas, and
nine coconuts; and so on
• Universe is the set of all alternative bundles that you can choose
Rational Preferences
• A rational preference relation is a preference relation that is transitive
and complete.
Transitive
• Transitive: if you prefer coffee to tea, and tea to cola, you must prefer
coffee to cola
• Axiom 2.5 Transitivity of ≽: If x ≽ y and y ≽ z, then x ≽ z (for all x, y,
z).
Transitive
• May not always hold in all relations. Just because Sam is in love with
Pat, and Pat is in love with Robin, it is not necessarily the case that
Sam is in love with Robin. Such relations are called intransitive.
• However, it makes sense that it holds for a person’s preference
Completeness
• You either prefer tea to coffee, or coffee to tea or both. It cannot be
the case that, you say ‘AAA, I do not know’
• Axiom 2.6 Completeness of ≽ : Either x ≽ y or y ≽ x (or both) (for all x,
y).
Completeness
• Not all relations are complete: Two people that you do not know. Do
you prefer one to another?
• Such relations are incomplete
Exercise 2.7
Assuming the universe is the set of all people – past, present, and
future – are the following relations transitive? Are they complete?
(a) “is the mother of”
(b) “is an ancestor of”
(c) “is the sister of”
(d) “detests”
Exercise 2.8
The enemy of your enemy:
Suppose it is true, as people say, that the enemy of your enemy is your
friend. What does this mean for the transitivity of “is the enemy of”?
Exercise 2.9
• Assuming the universe is the set of all natural numbers, meaning that
U = {1, 2, 3, 4, …}, are the following relations transitive? Are they
complete?
(a) “is at least as great as” (≥)
(b) “is equal to” (=)
(c) “is strictly greater than” (>)
(d) “is divisible by” (|)
Reflexive
•x≽x
• Need for completeness
Indifference
• x ~ y if and only if x ≽ y and y ≽ x.
Proposition 2.12 Properties of indifference The following conditions
hold:
(i) x ~ x (for all x) (Reflexive)
(ii) x ~ y -> y ~ x (for all x, y) (Symmetric)
(iii) x ~ y & y ~ z -> x ~ z (for all x, y, z) (Transitive)
Homework: Study the proof of proposition 2.12 and do exercises 2.13
and 2.14
Strict Preference
x ≻ y if and only if x ≽ y and it is not the case that y ≽ x.
Proposition 2.16 Properties of strict preference The following conditions
hold:
(i) x ≻ y & y ≻ z -> x ≻ z (for all x, y, z) (transitive)
(ii) x ≻ y -> not y ≻ x (for all x, y) (not symmetric)
(iii) not x ≻ x (for all x) (not reflexive)
Proof skipped.
Homework: do exercises 2.18, 2.22 (answers are on the back of the
book)
Exercise 2.25
Tea cups Imagine that there are 1000 cups of tea lined up in front of
you. The cups are identical except for one difference: the cup to the far
left (c1) contains one grain of sugar, the second from the left (c2)
contains two grains of sugar, the third from the left (c3) contains three
grains of sugar, and so on. Since you cannot tell the difference between
any two adjacent cups, you are indifferent between cn and cn+1 for all n
between 1 and 999 inclusive. Assuming that your preference relation is
rational, what is your preference between the cup to the far left (c1)
and the one to the far right (c1000)?
Cycling Relation
Cycling relation. If the following relations co-exist: xRy, yRz and zRx
• Does strict preference allow for cycling?
• Does weak preference allow for cycling?
• Homework: Exercise 2.26 and 2.27
Rational Choice under certainty
Rational Choice
to make rational choices, means
(i) that you have a rational preference relation (=preference ordering),
and
(ii) That whenever you are faced with a menu, you choose the most
preferred item, or (in the case of ties) one of the most preferred
items.
• Homework: Exercise 2.31
Rational Choice
• We do not judge preferences.
• As far as theory of rational choice is concerned, the fact that you
prefer a cool drink on a hot day to being roasted over an open fire is
just a brute fact; it is not a fact that needs to be grounded in an
account of what feels good or bad, pleasant or unpleasant, rewarding
or aversive.
Rational Choice
• Does not say that people are selfish. They are self interested!
• They use their own preference relation, but their preference may
include dying for others!
• The theory is silent about whether or not they pursue respectable
and moral ends. Rational people may be weird, evil, sadistic, selfish,
and morally repugnant, or saintly, inspiring, thoughtful, selfless,and
morally admirable
Utility
How would you give utility values to the following
preference ordering?
Utility
Utility
Homework: Study the proof of proposition 2.34, and do
exercise 2.35
Utility
• Utility just represents the preferences. It does not mean happiness,
satisfaction or any other thing. It is just an index.
• This utility function called ordinal utility, because all it does is allow
you to order things. (As opposed to cardinal utility.)