Lecture 8
• Consumer preferences
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Basic assumptions
Indifference curves
Marginal rate of substitution
Related issues
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Basic Assumptions
• These are the assumptions for a rational
consumer
• Preferences are complete:
– Consumers can compare and rank all market
baskets/options (>, <, ~)
– These preferences ignore costs
• Preferences are transitive:
– If A>B and B>C, then A>C
– Necessary for consumer rationality
• All goods are desirable (normal):
– Consumers always prefer more of any good
to less, i.e. no inferior goods
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Indifference Curves
• Definition:
An indifference curve represents all combinations
of market baskets that provide the same level of
satisfaction to a person
• Shape of an indifference curve:
Downward sloping from left to right
• An indifference map:
– An indifference map is a set of indifference
curves that describes a person’s preferences
– An indifference curve to the further right
represents a higher utility
– Indifference curves for the same person (in an
indifference map) never intersects
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Marginal Rate of Substitution
• Purpose:
To quantify the amount of one good a consumer
will give up to obtain more of another good
• Definition:
∆X > 0
– MRS = - ∆Y/∆
– At a particular point, MRS = - dY/dX so that MRS
is the negative of the slope of the indifference
curve at that point
• For a convex indifference curve:
– We have implicitly assumed that the MRS is
diminishing as quantity increases
– Intuition: a consumer would prefer to give up
fewer and fewer units of Y to get an additional
unit of X
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Related Issues
• Complements and Substitutes:
– Indifference curve for perfect substitutes, if
MRS is constant
– Indifference curve for perfect complements if
MRS is zero
• Ordinal vs. cardinal:
– Ordinal: place market baskets in the order of
most preferred to least preferred, but does not
specify how much one market basket is
preferred to another
– Cardinal: provide a quantitative measurement
of preference for each market basket in terms
of basic units (useful for aggregation)
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