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Chapter Three
Preferences

Rationality in Economics
• Behavioral Postulate:
A decisionmaker always chooses its most
preferred alternative from its set of
available alternatives.
• So to model choice we must model
decisionmakers’ preferences.

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Preference Relations
• Comparing two different consumption
bundles, x and y:
• strict preference: x is more preferred than is y.
• weak preference: x is as at least as preferred as is
y.
• indifference: x is exactly as preferred as is y.

Preference Relations
• Strict preference, weak preference and
indifference are all preference relations.
• Particularly, they are ordinal relations; i.e.
they state only the order in which bundles
are preferred.

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Preference Relations
• > denotes strict preference so
x > y means that bundle x is preferred strictly to
bundle y.
• ~ denotes indifference; x ~ y means x and y are
equally preferred.
• ≥ denotes weak preference;
x ≥ y means x is preferred at least as much as is y.

Preference Relations
• x ≥ y and y ≥ x imply x ~ y.

• x ≥ y and (not y ≥ x) imply x > y.

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Assumptions about Preference

Relations
• Completeness: For any two bundles x and
y it is always possible to make the
statement that either
x ≥ y
or
y ≥ x

Assumptions about Preference

Relations
• Reflexivity: Any bundle x is always at least
as preferred as itself; i.e.

x ≥ x.

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Assumptions about Preference

Relations
• Transitivity: If
x is at least as preferred as y, and
y is at least as preferred as z, then
x is at least as preferred as z; i.e.

x ≥ y and y ≥ z x ≥ z.

Indifference Curves
• Take a reference bundle x’. The set of all
bundles equally preferred to x’ is the
indifference curve containing x’; the set of
all bundles y ~ x’.
• Since an indifference “curve” is not always
a curve a better name might be an
indifference “set”.

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Indifference Curves
x2 x’ ~ x” ~ x”’
x’

x”

x”’

x1

Indifference Curves
x2 z> x > y
x

x1

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Indifference Curves
I1 All bundles in I1 are
x2
x strictly preferred to
all in I2.
z
I2

All bundles in I2 are

y strictly preferred to
I3
all in I3.
x1

Indifference Curves
x2
WP(x), the set of
x bundles weakly
preferred to x.

I(x) I(x’)

x1

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Indifference Curves
x2
WP(x), the set of
x bundles weakly
preferred to x.
WP(x)
includes
I(x) I(x).

x1

Indifference Curves
x2
SP(x), the set of
x bundles strictly
preferred to x,
does not
include
I(x) I(x).

x1

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Indifference Curves Cannot

Intersect
x2 I2 From I1, x ~ y. From I2, x ~ z.
I1 Therefore y ~ z.

x
y
z

x1

Indifference Curves Cannot

Intersect
x2 I2 From I1, x ~ y. From I2, x ~ z.
I1 Therefore y ~ z. But from I1
p
and I2 we see y z, a
contradiction.
x
y
z

x1

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Slopes of Indifference Curves

• When more of a commodity is always
preferred, the commodity is a good.
• If every commodity is a good then
indifference curves are negatively sloped.

Slopes of Indifference Curves

Good 2
Two goods
a negatively sloped
indifference curve.

Good 1

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Slopes of Indifference Curves

• If less of a commodity is always preferred
then the commodity is a bad.

Slopes of Indifference Curves

Good 2
One good and one
bad a
positively sloped
indifference curve.

Bad 1

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Extreme Cases of Indifference

Curves; Perfect Substitutes
• If a consumer always regards units of
commodities 1 and 2 as equivalent, then
the commodities are perfect substitutes
and only the total amount of the two
commodities in bundles determines their
preference rank-order.

Extreme Cases of Indifference

Curves; Perfect Substitutes
x2
Slopes are constant at - 1.
15 I2
Bundles in I2 all have a total
8 of 15 units and are strictly
preferred to all bundles in
I1 I1, which have a total of
only 8 units in them.
8 15 x1

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Extreme Cases of Indifference

Curves; Perfect Complements
• If a consumer always consumes
commodities 1 and 2 in fixed proportion
(e.g. one-to-one), then the commodities
are perfect complements and only the
number of pairs of units of the two
commodities determines the preference
rank-order of bundles.

Extreme Cases of Indifference

Curves; Perfect Complements
x2
45o Each of (5,5), (5,9)
and (9,5) contains
5 pairs so each is
equally preferred.
9
5 I1

5 9 x1

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Extreme Cases of Indifference

Curves; Perfect Complements
x2
45o Since each of (5,5),
(5,9) and (9,5)
contains 5 pairs,
each is less
9 I2 preferred than the
bundle (9,9) which
5 I1 contains 9 pairs.

5 9 x1

Preferences Exhibiting
Satiation
• A bundle strictly preferred to any other is a
satiation point or a bliss point.
• What do indifference curves look like for
preferences exhibiting satiation?

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Indifference Curves Exhibiting

Satiation
x2
Satiation
(bliss)
point

x1

Indifference Curves Exhibiting

Satiation
x2
Satiation
(bliss)
point
Better

x1

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Indifference Curves Exhibiting

Satiation
x2
Satiation
(bliss)
point
Better

x1

Indifference Curves for

Discrete Commodities
• A commodity is infinitely divisible if it can
be acquired in any quantity; e.g. water or
cheese.
• A commodity is discrete if it comes in unit
lumps of 1, 2, 3, … and so on; e.g. aircraft,
ships and refrigerators.

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Indifference Curves for

Discrete Commodities
• Suppose commodity 2 is an infinitely
divisible good (gasoline) while commodity
1 is a discrete good (aircraft). What do
indifference “curves” look like?

Indifference Curves With a

Discrete Good
Gas-
oline Indifference “curves”
are collections of
discrete points.

0 1 2 3 4 Aircraft

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Well-Behaved Preferences
• A preference relation is “well-behaved” if
it is monotonic and convex.
• Monotonicity: More of any commodity is
always preferred (i.e. no satiation and
every commodity is a good).

Well-Behaved Preferences
• Convexity: Mixtures of bundles are (at
least weakly) preferred to the bundles
themselves. E.g., the 50-50 mixture of the
bundles x and y is
z = (0.5)x + (0.5)y.
z is at least as preferred as x or y.

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Well-Behaved Preferences --
Convexity.

x2 x

x2+y2 x+y is strictly preferred to

z=
2 both x and y.
2
y
y2
x1 x1+y1 y1
2

Well-Behaved Preferences --
Convexity.

x2 x
z =(tx1+(1-t)y1, tx2+(1-t)y2)
is preferred to x and y
for all 0 < t < 1.
y
y2
x1 y1

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Well-Behaved Preferences --
Convexity.
Preferences are strictly convex
x when all mixtures z
x2
are strictly
z preferred to their
component
bundles x and y.
y
y2
x1 y1

Well-Behaved Preferences --
Weak Convexity.
x’ Preferences are
z’ weakly convex if at
least one mixture z
is equally preferred
x to a component
z
y bundle.
y’

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Non-Convex Preferences

x2
The mixture z
z is less preferred
than x or y.
y2
x1 y1

More Non-Convex Preferences

x2
The mixture z
z is less preferred
than x or y.
y2
x1 y1

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Slopes of Indifference Curves

• The slope of an indifference curve is its
marginal rate-of-substitution (MRS).
• the marginal rate of substitution is the rate
at which a consumer is ready to give up
one good in exchange for another good
while maintaining the same level of utility.
• How can a MRS be calculated?

Marginal Rate of Substitution

x2
MRS at x’ is the slope of the
indifference curve at x’

x’

x1

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Marginal Rate of Substitution

x2
MRS at x’ is
lim {Dx2/Dx1}
Dx1 0
Dx2 x’ = dx2/dx1 at x’

Dx1

x1

Marginal Rate of Substitution

x2 dx2 = MRS  dx1 so, at x’, MRS
is the rate at which the
consumer is only just willing to
exchange commodity 2 for a
x’ small amount of commodity 1.
dx2
dx1

x1

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MRS & Ind. Curve Properties

Good 2
Two goods
a negatively sloped
indifference curve

MRS < 0.

Good 1

MRS & Ind. Curve Properties

Good 2
One good and one
bad a positively
sloped indifference curve

MRS > 0.

Bad 1

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MRS & Ind. Curve Properties

Good 2
MRS = - 5
MRS always increases with x1
(becomes less negative) if and
only if preferences are strictly
convex.

MRS = - 0.5 Good 1

MRS & Ind. Curve Properties

x2 MRS decreases
MRS = - 0.5
(becomes more negative)
as x1 increases
nonconvex preferences

MRS = - 5
x1

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MRS & Ind. Curve Properties

MRS is not always increasing as x1
x2
increases nonconvex
preferences.
MRS = - 1
MRS
= - 0.5
MRS = - 2

x1

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