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## Intermediate Microeconomics

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### Intermediate Microeconomics Preferences Consumer Behavior Budget Set organizes information about possible choices available to a given consumer. – PowerPoint PPT presentation

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Title: Intermediate Microeconomics

1
Intermediate Microeconomics
• Preferences

2
Consumer Behavior
• Budget Set organizes information about possible
choices available to a given consumer.
• Next step is to determine how a consumer will
choose among the bundles available in his or her
budget set.
• To do so, we make the seemingly obvious
assumption that individuals are rational
• Each individual chooses the bundle he or she most
prefers among all bundles available in his or her
budget set.
• Therefore, we need to develop a theory of
preferences, that is both flexible and yet
restrictive enough to be useful for understanding
how choices will change as the economic
environment changes.

3
Theory of Preferences
• Consider again a bundle of goods denoted A-q1A,
q2A, , qnA
• For any given individual and any given bundle A,
we want to be able to describe the following
sets
• Strictly preferred set all bundles the
individual strictly prefers to A.
• Weakly preferred set all bundles the individual
weakly prefers to A (i.e. likes at least as much
as A)
• Any bundle not in weakly preferred set, the
individual must like strictly less than A.

4
Preferences
• 3 axioms in our theory of consumer preferences
• Completeness An individual can weakly rank any
two possible bundles.
• Reflexivity A bundle is at least as good as
itself.
• Transitivity If a bundle C is strictly
preferred to a bundle A, and an individual is
indifferent between a bundle A and another bundle
D, then the individual must also strictly prefer
bundle C to bundle D.

5
Preferences
• Final common assumption - preferences exhibit
non-satiation or monotonicity.
• Weaker version more cant be worse.
• Essentially assumes free-disposal
• Stronger version more is always better
• Certainly not true at levels (100 donuts does me
no better than 99)
• For practical purposes though, not bad, as we
want to model situations where individuals have
to make choices between things they value.

6
Preferences
• Key issue we want to understand and analyze in
economics is trade-offs.
• e.g. how much of one good is an individual
willing to trade-off to consume more of another
good?
• Our preference axioms allow us to consider such
trade-offs via indifference curves.
• For any given bundle A, there is an indifference
curve that connects A to each bundle B where a
given consumer is indifferent between A and B.

7
Indifference Curves
• Characteristics of Indifference Curves
• Consider one of your indifference curves between
number of chips and ounces of Coke.
• Is every possible bundle on an indifference
curve? Why or why not?
• How many indifference curves are there?
• Will slope of indifference curves be positive or
negative? How do we know?
• Can indifference curves cross? Why or why not?
• If A is on a higher indifference curve than B,
what does this mean? How do we know this?

8
Interpreting Indifference Curves
q2 q2
• Indifference curve indicates that at bundle
q1,q2, an individual will be willing to give
up ?q2 units of good 2 to increase consumption of
good 1 by ?q1.
• What happens as ?q1 goes to zero?

?q1
-?q2
q1
q1
9
Interpreting Indifference Curves
• Marginal Rate of Substitution (MRS) the slope
of indifference curve at a given point.
• MRS indicates an individuals willingness-to-pay
for a marginal increase of one good in terms of
the other, at a given bundle.
• So how do you interpret an indifference curve
when it is very steep at a given bundle (i.e.
slope large in magnitude)?
• How about when it is relatively flat?

10
Well-behaved preferences
• In addition to our three Axioms and monotonicity,
we will also often assume preferences are convex.
• Convex preferences - If bundles
• B-q1B, q2B and C-q1C , q2C
• are in weakly preferred set to A, then so will
• (q1B q1C)/2 , (q2B q2C)/2 .
• Intuition averages are at least as good as
extremes, or that individuals prefer to have a
combination of goods at moderate levels to lots
of one and little of the other (consider chips
and coke)
• Monotonic and Convex preferences are called
well-behaved preferences.

11
Interpreting Indifference Curves
• Consider an indifference curve of following form.
• Does it represent convex preferences?
• What does this shape reveal about MRS as q1
increases and q2 decreases?
• What is intuition?

q2
q1
12
Interpreting Indifference Curves
• Diminishing MRS
• Implies an individuals willingness to trade one
good for another diminishes the less he has of
that good.
• Slope of Indifference Curve decreases as q1
increases and q2 falls.
• Examples
• Chips and Coke?
• Coke and a composite good?
• Coke and Apple Juice?
• What is intuition behind different shapes of
indifference curves?

13
Interpreting Indifference Curves
• Perfect substitutes - constant MRS
• Examples?
• What will indifference curves look like?
• Perfect Complements must consume in fixed
proportions, or individual not willing to trade
off some of one for more of another, therefore
MRS is undefined.
• Examples?
• What will indifference curves look like?
• Are such preferences well-behaved?
• Examples of when preferences might not be
well-behaved?

14
Modeling Preferences over Other Types of Goods
• Suppose again you work for Doctors Without
Borders.
• What will your indifference curves look like
between people cured of Tuberculosis vs.
people cured of AIDS?
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