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Understanding Consumer Preferences and MRS

The document discusses consumer preferences, outlining strict preferences, indifference, weak preferences, and assumptions of completeness, reflexivity, and transitivity. It also describes well-behaved preferences characterized by monotonicity and convexity, along with the concept of marginal rate of substitution (MRS) which measures the willingness to substitute one good for another. Additionally, it addresses the nature of indifference curves and their properties.

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3 views21 pages

Understanding Consumer Preferences and MRS

The document discusses consumer preferences, outlining strict preferences, indifference, weak preferences, and assumptions of completeness, reflexivity, and transitivity. It also describes well-behaved preferences characterized by monotonicity and convexity, along with the concept of marginal rate of substitution (MRS) which measures the willingness to substitute one good for another. Additionally, it addresses the nature of indifference curves and their properties.

Uploaded by

mostafa allam
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Preferences

Preference Relation
The consumer strictly prefers bundle X to
bundle Y:

( x 1, x 2 ) f ( y 1, y 2 )
The consumer is indifferent between X and
Y:
( x 1, x 2 ) ~ ( y 1, y 2 )
Weak Preference
If
( x 1, x 2 ) f ( y 1, y 2 )
or
( x 1, x 2 ) ~ ( y 1, y 2 )
Then: ( x 1, x 2 ) ! ( y 1, y 2 )
How are the relations related?
Q: What do these two relations imply?
( x 1, x 2 ) ! ( y 1, y 2 )
( y 1, y 2 ) ! ( x 1, x 2 )
How are the relations related?
A: The consumer is indifferent between X and
Y:
( x 1, x 2 ) ~ ( y 1, y 2 )
Assumption I: Complete
Preferences
For any two bundles X and Y:
X preferred to Y:

( x 1, x 2 ) ! ( y 1, y 2 )
Y preferred to X:

( y 1, y 2 ) ! ( x 1, x 2 )
Indifference:
( x 1, x 2 ) ~ ( y 1, y 2 )
Assumption II: Reflexive
Any bundle X is at least as good as itself:

( x 1, x 2 ) ! ( x 1, x 2 )
Assumption III: Transitive
If:
( x 1, x 2 ) ! ( y 1, y 2 )
And:

( y 1, y 2 ) ! ( z 1, z 2 )
Then:
( x 1, x 2 ) ! ( z 1 , z 2 )
Indifference curves

x2 Indifference curve

x2 Weakly preferred set

x1 x1
Q: Can indifference curves cross?

x2

Z
Y
x1
Perfect substitutes

x2

x1
Perfect complements
x2

x1
Satiation
x2

x2

x1 x1
Well-behaved preferences
Let’s impose some extra assumptions to
rule out less interesting situations
Well-behaved preferences satisfy two
properties:
1. Monotonicity
2. Convexity
Monotonicity
Consider two bundles:
( x 1, x 2 ), ( y 1, y 2 )
where Y has at least as much of both goods
and more of one.
Then:
( y 1, y 2 ) f ( x 1, x 2 )
Monotonicity implies that indifference
curves have negative slopes
Indifference curves have negative
slopes

x2

x2

x1 x1
Convexity

Consider two bundles:


( x 1, x 2 ) ~ ( y 1, y 2 )
Convexity implies that, for 0 ≤ t ≤ 1

( t x 1 + (1 − t ) y 1, t x 2 + (1 − t ) y 2 )
!
( x 1, x 2)
Convex preferences
x2
y2

x2
y1 x1 x1
Non-convex preferences
x2
y2

x2
y1 x1 x1
Marginal rate of substitution

x2 The MRS is the


slope of the
indifference curve
at a point
x2 ( x 1, x 2 )
MRS=derivative of
indifference curve

x1 x1
Interpretation of MRS
The MRS measures the rate at which the
consumer is willing to substitute one good
for the other.
If good 2 is measured in dollars, the MRS
measures the consumer’s willingness to pay
for an extra unit of good 1.

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