Microeconomics 1

WEEK 5
PREFERENCES and INDIFFERENCE CURVES

27 Ekim 2021 Çarşamba / 27 October 2021 Wednesday

 TOTAL UTILITY
U
WATER Total Utility
(in glasses of 200 ml ) ( in «utils» )
0 0
1 16
2 24
3 28
4 30
5 30
6 28
 TOTAL UTILITY and MARGINAL UTILITY
U
WATER Total Utility
(in glasses of 200 ml ) ( in «utils» )
0 0
1 16
2 24
3 28
4 30
5 30
6 28
 TOTAL UTILITY and MARGINAL UTILITY
U MU
WATER Total Utility Marginal Utility
(in glasses of 200 ml ) ( in «utils» ) ( in «utils» )
0 0 -
1 16 16
2 24 8
3 28 4
4 30 2
5 30 0
6 28 - 2
 TOTAL UTILITY and MARGINAL UTILITY
U MU
WATER Total Utility Marginal Utility
(in glasses of 200 ml ) ( in «utils» ) ( in «utils» )
0 0 -
1 16 16
2 24 8
3 28 4
4 30 2
5 30 0
6 28 - 2
 PROPERTIES of / ASSUMPTIONS on
PREFERENCES
1. COMPLETENESS

2. NONSATIATION / «More is better than less»

3. TRANSITIVITY
 COMPLETENESS
Consumers can compare and rank all possible baskets.

There are three possibilities for any given two bundles A and B as follows:

POSSIBILITY 1 : A is preferred over B  A B

POSSIBILITY 2 : B is preferred over A  B A

POSSIBILITY 3 : A is as good as B  being «INDIFFERENT» btw A and B

A ≈ B
 COMPLETENESS
Consumers can compare and rank all possible baskets.

There are three possibilities for any given two bundles A and B as follows:

POSSIBILITY 1 : A B  u(A) ≥ u(B)

POSSIBILITY 2 : B A  u(B) ≥ u(A)

POSSIBILITY 3 : A ≈ B  u(A) = u(B)

 COMPLETENESS

Suppose we are given two bundles A and B containing quantities of two goods,
say Good X and Good Y, where x stands for the amount of Good X and y
stands for the amount of Good Y. Then bundles A and B can be shown as
follows:
A(xA; yA) and B (xB; yB)

Now, suppose bundle A and B contain the following:

A(xA ; yA) = (4 ; 2)

B (xB ; yB) = (3 ; 3)
 COMPLETENESS

For the preference relation be complete, the consumer faced by these two bundles will:

EITHER find bundle A superior than bundle B :

A(4 ; 2) B(3 ; 3)

OR find bundle B superior than bundle A :

B(3 ; 3) A(4 ; 2)

OR find both bundles equally satisfactory:

A(4 ; 2) B(3 ; 3)
 COMPLETENESS

… which means, the consumer ranks these bundles, attaching different utility levels to each bundle.
She / he thinks that:

EITHER bundle A generates higher utility than bundle B :

u[A(4 ; 2)] ≥ u[B(3 ; 3)]

OR, bundle B generates higher utility than bundle A :

u[B(3 ; 3)] ≥ u[A(4 ; 2)]

OR, bundle A generates the same amount of utility as bundle B :

u[A(4 ; 2)] = u[B(3 ; 3)]

 NONSATIATION
«More is better than less»
• Goods are assumed to be desirable.

• i.e., goods are assumed to be good!

• Consequently, consumers always prefer more of any good to less.

• Consumers are insatiable  they are never satisfied or satiated; more is always better,
even if just a little better.

• Ex: A ( 4 ; 4.1 ) and B ( 4 ; 4 )  A B

TRANSITIVITY - Preferences are transitive. Transitivity is normally
regarded as necessary for consumer consistency.
Suppose, this time, we are given three bundles A and B and C, containing quantities of two goods, say Good X
and Good Y. Then we have:
A(xA; yA) and B ( x B ; y B ) and C (xC; yC)
If the consumer finds A better than B, and she finds B better than C at the same time, then she must find A
better than C as well:

A(xA; yA) B (xB; yB)

A(xA; yA) C (xC; yC)
B (xB; yB) C (xC; yC)
 TRANSITIVITY – ex.
Suppose, this time, we are given three bundles A and B and C, containing quantities of two
goods, say lahmacun and ayran. If the three possible combinations are:
A ( 3 lahmacun ; 2 ayran ) and B ( 2 lahmacun ; 2 ayran ) and C ( 2 lahmacun
; 1 ayran)
If the consumer finds A better than B, and he finds B better than C at the same time, then
he must find A better than C as well:

u [A ( 3 lahmacun ; 2 ayran ) ] ≥ u [ B ( 2 lahmacun ; 2 ayran ) ]


u [ B ( 2 lahmacun ; 2 ayran ) ] ≥ u [ C ( 2 lahmacun ; 1 ayran) ]

 u [A ( 3 lahmacun ; 2 ayran ) ] ≥ u [C ( 2 lahmacun ; 1 ayran) ]

 BUNDLES / MARKET BASKETS

A ( x 1 ; y 1 ) = A ( 4 cups of coffee ; 3 slices of cake )

B ( x 2 ; y 2 ) = B ( 3 cups of coffee ; 2 slices of cake )

C ( x 3 ; y 3 ) = C ( 2 cups of coffee ; 1 slice of cake )

D ( x 4 ; y 4 ) = D ( 1 cup of coffee ; 1 slice of cake )

 COMMODITY PLANE
y

A
3
B
2
D C
1

X
1 2 3 4
 COMMODITY PLANE
y

Compartment IV Compartment I
A
3
B
2
D C Compartment II
1
Compartment III
X
1 2 3 4
 COMMODITY PLANE
y
Compartment I
Compartment IV
A
3
B
2
D C Compartment II
1
Compartment III
X
1 2 3 4
 COMMODITY PLANE
y
Compartment I
Compartment IV
A
3
B
2
Compartment III
Compartment II
1
D C
X
1 2 3 4
 COMMODITY PLANE
y

E A
3
B
2
D C G
1

X
1 2 3 4
 y COMMODITY PLANE

IV
Compartment I
H
A
3
B
2
Compartment III
K
1 II
D C
X
1 2 3 4
 y INDIFFERENCE CURVE
IV
Compartment I
H
A
3
B
2
Compartment III
K II
1
D C Indifference Curve
X
1 2 3 4
 INDIFFERENCE CURVES
• The geometric locus (=place) of all bundles which could give the consumer
exactly the same amount of satisfaction, or utility.

• The bundles along any given indifference curve ( henceforth, IC ) are equally
satisfactory.

• Suppose that bundle X contains 2 cups of coffee and 1 bar of chocolate, and
gives us, say u0 level of utility. Suppose also that bundle Y contains 1 cup of
coffee and 1.25 bars of chocolate, and still gives us u0 level of utility. Then it
must be that bundle X and bundle Y are equally well and they are on the
same indifference curve.
CHARACTERISTICS of INDIFFERENCE CURVES
1. (Definition, at the same time.) The level of utility along a given IC curve is
constant, or say, unchanged.
2. There are so many possible levels of utility  There are so many IC curves
on the commodity plane. There is only one IC curve for every level of
utility.  IC family / IC map
3. The greater the level of utility the higher the IC curves. The smaller the
level of utility the lower the IC curves.
4. IC curves cannot cross each other. If they did the the «transitivity» and the
«nonsatiation» properties would be violated.
5. IC curves are negatively sloped.
6. IC curves are convex, generating diminishing marginal rate of substitution
among two goods in question.
 INDIFFERENCE CURVE MAP
North-east
direction

South-west
direction
DIMINISHING MARGINAL RATE OF SUBSTITUTION

• MRS XY = The rate at which one good is

sustituted for another in consumption.

• It is equal to the absolute value of the slope of

the IC curve at hand.

• It decreases as we go down along the IC curve.