Question

List and carefully explain the three assumptions made about consumer preferences.

Answer 1

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Completeness. If A and B are any two situations, the individual can always specify exactly one of the following three possibilities: 1. “A is preferred to B,” 2. “B is preferred to A,” or 3. “A and B are equally attractive.” Consequently, people are assumed not to be paralyzed by indecision: They completely understand and can always make up their minds about the desirability of any two alternatives. The assumption also rules out the possibility that an individual can report both that A is preferred to B and that B is preferred to A.

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. Transitivity. If an individual reports that “A is preferred to B” and “B is preferred to C,” then he or she must also report that “A is preferred to C.” This assumption states that the individual’s choices are internally consistent. Such an assumption can be subjected to empirical study. Generally, such studies conclude that a person’s choices are indeed transitive, but this conclusion must be modified in cases where the individual may not fully understand the consequences of the choices he or she is making. Because, for the most part, we will assume choices are fully informed (but see the discussion of uncertainty in Chapter 7 and elsewhere), the transitivity property seems to be an appropriate assumption to make about preferences.

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. Continuity. If an individual reports “A is preferred to B,” then situations suitably “close to” A must also be preferred to B. This rather technical assumption is required if we wish to analyze individuals’ responses to relatively small changes in income and prices. The purpose of the assumption is to rule out certain kinds of discontinuous, knife-edge preferences that pose problems for a mathematical development of the theory of choice. Assuming continuity does not seem to risk missing types of economic behavior that are important in the real world.