ch03 - Chapter 3 PREFERENCES AND UTILITY 1 Preferences and...

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1 Chapter 3 PREFERENCES AND UTILITY

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2 Preferences and Utilities • We want to understand how people make decision • To this end, we need to understand what people value and how much they value different items • Preferences and utility functions are helpful
3 Preferences • Suppose that an individual must choose between situations A, B, and C • For example, A = attend Econ 11, B = sleep until noon, C = go to the beach • To decide, most people form a ranking for the three alternative and choose • For example, A > B > C

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4 Preferences • Preferences are rankings with particular properties (axioms)
5 Axioms of Rational Choice • Completeness – if A and B are any two alternatives, an individual will always be in one of the following three possibilities: • A is preferred to B • B is preferred to A • A and B are equally attractive

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6 Axioms of Rational Choice • Transitivity – if A is preferred to B, and B is preferred to C, then A is preferred to C – assumes that the individual’s choices are internally consistent
7 Axioms of Rational Choice • Continuity – if A is preferred to B, then alternatives suitably “close to” A must also be preferred to B – used to analyze individuals’ responses to relatively small changes in income and prices

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8 Utility • If this axioms are satisfied, we can represent the preferences of each individual using a utility function. • Using the utility function corresponding to each individual we can determine if s/he prefers A or B: U (A) > U (B)
9 Utility • The utility function is generally ordinal: – We can use the utility function to rank the desirability of different consumption bundles – But we cannot determine the level of happiness/utility that an individual associates with a particular bundle • In general, it is also not possible to compare utilities across people

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10 Utility • The individual utility is affected by the consumption of physical commodities, psychological attitudes, peer group pressures, personal experiences, and the general cultural environment • In this course we will focus of the effect of
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This note was uploaded on 10/18/2010 for the course ECON 11 taught by Professor Cunningham during the Spring '08 term at UCLA.

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ch03 - Chapter 3 PREFERENCES AND UTILITY 1 Preferences and...

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