ECO201 Intermediate Microeconomics Notes Fall 2024 PDF

ECO201 Intermediate Microeconomics Dr Amir Jahan Khan [email protected] Topic 3 Preferences Department of Economics Institute of Business Administration, Karachi Fall Semester 2024...

ECO201 Intermediate Microeconomics Dr Amir Jahan Khan [email protected] Topic 3 Preferences Department of Economics Institute of Business Administration, Karachi Fall Semester 2024 1 Rationality in Economics Behavioral Postulate: A decision maker always chooses his or her most preferred alternative from his or her set of available alternatives. So, in order to understand and model choice, we must model decision maker preferences. Copyright © 2019 Hal R. Varian Preference Relations – 1 Comparing two different consumption bundles x and y: strict preference: x is more preferable than y. weak preference: x is at least as preferable as y. indifference: x and y are equally preferable. Copyright © 2019 Hal R. Varian Preference Relations – 2 Strict preference, weak preference, and indifference are all preference relations. In particular, they are ordinal relations; i.e., they state only the order in which bundles are preferred. Copyright © 2019 Hal R. Varian Preference Relations – 3 ≻ denotes strict preference. x ≻ y means that bundle x is strictly preferred to bundle y. ~ denotes indifference. x  y means that the individual is indifferent between bundles x and y. ≿ denotes weak preference. x ≿ y means that bundle x is preferred at least as much as is bundle y. Copyright © 2019 Hal R. Varian Preference Relations (are not independent)– 4 x ≿ y and y ≿ x imply x  y. (Apple vs Orange) x ≿ y and (not y ≿ x) imply x ≻ y. They are called ordinal relations because they state only the order in which bundles are preferred. Copyright © 2019 Hal R. Varian Assumptions about Preference Relations – 1 Completeness: For any two bundles x and y it is always possible to make the statement that either x≿y or Completeness is making statement about the order y ≿ x. Copyright © 2019 Hal R. Varian Assumptions about Preference Relations – 3 if u cannot impose completeness you cannot impose the ranking preference. 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. Copyright © 2019 Hal R. Varian Indifference Curves – 1 Consider a particular bundle, xʹ. The set of all bundles equally preferred to xʹ is the indifference curve containing xʹ; the set of all bundles y  xʹ. Since an indifference “curve” is not always a curve a better name might be an indifference “set.” Copyright © 2019 Hal R. Varian Indifference Curves – 2 Copyright © 2019 Hal R. Varian Indifference Curves – 3 z is strictly preferred as compared to x and x is strictly compared to y Copyright © 2019 Hal R. Varian Indifference Curves – 4 Copyright © 2019 Hal R. Varian Indifference Curves – 5 Copyright © 2019 Hal R. Varian Indifference Curves – 6 Copyright © 2019 Hal R. Varian Indifference Curves Cannot Intersect The lines cannot cross each other because of the transitivity ( u have to put them into ranking Copyright © 2019 Hal R. Varian Slopes of Indifference Curves – 1 If more of a commodity is always preferred to less, then the commodity is a “good.” If every commodity is a good then indifference curves are negatively sloped. Copyright © 2019 Hal R. Varian Slopes of Indifference Curves – 2 Copyright © 2019 Hal R. Varian Slopes of Indifference Curves – 3 If less of a commodity is always preferred then the commodity is a “bad.” Copyright © 2019 Hal R. Varian Slopes of Indifference Curves – 4 Copyright © 2019 Hal R. Varian Extreme Cases of Indifference Curves: Perfect Substitutes – 1 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. Copyright © 2019 Hal R. Varian Extreme Cases of Indifference Curves: Perfect Substitutes – 2 here trade-off is constant(utility) because u get commodities in a fixed proportion. e.g: (1 blue pen for 1 Red pen) Here the good is preferred as good as the other Copyright © 2019 Hal R. Varian Extreme Cases of Indifference Curves: Perfect Complements – 1 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. Copyright © 2019 Hal R. Varian Extreme Cases of Indifference Curves: Perfect Complements – 2 Copyright © 2019 Hal R. Varian Preferences Exhibiting Satiation A bundle strictly preferred to any other is a “satiation point” or a “bliss point.” Copyright © 2019 Hal R. Varian Indifference Curves Exhibiting Satiation – 1 Copyright © 2019 Hal R. Varian Indifference Curves Exhibiting Satiation – 2 This point is constant having same proportion of goods Copyright © 2019 Hal R. Varian Indifference Curves for Discrete Commodities – 1 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, cars, ships, and refrigerators. Copyright © 2019 Hal R. Varian Indifference Curves for Discrete Commodities – 2 Suppose commodity 2 is an infinitely divisible good (gasoline/fuel) while commodity 1 is a discrete good (aircraft/car). What do the indifference “curves” look like? Copyright © 2019 Hal R. Varian Indifference Curves with a Discrete Good due to the property of discrete there is no smoothness in indifference curves. Copyright © 2019 Hal R. Varian Well-Behaved Preferences – 1 A preference relation is “well-behaved” if it is both: Monotonic It makes the indifference curve have negative slope (by demanding one commodity more than the other). Convex Monotonicity: More of any commodity is always preferred (i.e., no satiation and every commodity is a good). Copyright © 2019 Hal R. Varian Well-Behaved Preferences – 2 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 is at least as preferred as x or y. A = sandwich having more Bread B = sandwich having more Meat Balanced bundle if u mix both A+B/2 u will be better off A+B/2 at least weakly preferred to A A+B/2 at least weakly preferred to B Copyright © 2019 Hal R. Varian Well-Behaved Preferences: Convexity – 1 here z is the point that we get both monoticity and convexity Copyright © 2019 Hal R. Varian Well-Behaved Preferences: Convexity – 2 Copyright © 2019 Hal R. Varian Non-Convex Preferences Copyright © 2019 Hal R. Varian Slopes of Indifference Curves The slope of an indifference curve is its “marginal rate of substitution” (MRS). How can a MRS be calculated? Copyright © 2019 Hal R. Varian Marginal Rate of Substitution – 1 The rate of change depends on steeper or flatter side of the slope curve The point at which u want to consume more of good 1 and willing to exchange good 2 at constant happiness. Copyright © 2019 Hal R. Varian Marginal Rate of Substitution – 2 Ask sir about diminishing MRS Copyright © 2019 Hal R. Varian MRS and Indifference Curve Properties – 1 Copyright © 2019 Hal R. Varian