CH3 Notes - 3 3.1 Consumer Preferences and the Concept of...

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13 | P a ge 3. Consumer Preferences and the Concept of Utility 3.1. Representations of Preferences In this chapter we are concerned with the preferences of consumers Consumer preferences are indications of how a consumer would rank, that is, compare the desirability, of any two possible baskets of goods and services, assuming that the baskets were available to the consumer at no cost. head2right A basket is a combination of goods and services that an individual might consume. Assumptions about Consumer Preferences There are three basic assumptions that underlie the theory of consumer choice. These assumptions take for granted that consumers behave rationally. head2right Preferences are complete : This means that a consumer is able to rank any two baskets A and B, meaning she can determine which of the following is true: square4 She prefers A to B. square4 She prefers B to A. square4 He is indifferent between A and B. head2right Preferences are Transitive : This means that a consumer makes choices that are consistent with each other. In particular: square4 If A is preferred to B and B is preferred to C then it must be that A is preferred to C. head2right More is Better : Basically this means that having more of a good is better for a consumer. square4 If there are two baskets with the same goods, but basket B has more of each good, then it must be that B is preferred to A. Ordinal and Cardinal Ranking Throughout this course we will be interested in two types of rankings: ordinal and cardinal. head2right Ordinal rankings give us information about the order in which a consuer ranks baskets, they indicate whether a consumer prefers one basket to another, but do not contain quantitative information about the intensity of that preference. head2right Cardinal rankings give us information about the intensity of a consumer’s preferences; they are quantitative measures of the intensity of a preference for one basket over another. We find that consumers are able to give ordinal rankings in most situations, however, cardinal rankings are more problematic, and luckily it turns out that ordinal rankings normally provide enough information to explain a consumer’s decisions.
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