Theory of Consumer Preferences
Consumer preferences are defined as the subjective (individual) tastes, as measured by utility, of
various bundles of goods. They permit the consumer to rank these bundles of goods according to
the levels of utility they give the consumer. Note that preferences are independent of income and
prices. Ability to purchase goods does not determine a consumer’s likes or dislikes. One can
have a preference for Porsches over Fords but only have the financial means to drive a Ford.
These preferences can be modeled and mapped through the use of indifference curves. In order
to graphically portray consumer preferences, we need to define some terms. First, since we will
be working in two dimensions (2-d graphs), we assume a two good world. These could be any two goods. One common treatment is to define one good, say food, and let the other good be a
composite of all other goods. For expository simplicity (making things easier for me), let’s
define the two goods as Good X and Good Y. The axes of the graph then measure amounts of
Good X on the horizontal, and amounts of Good Y on the vertical. Each point in this Cartesian
space then defines some combination of goods X and Y. We call these combinations
commodity bundles.
The goal of the theory of preferences is for the consumer to be able to rank these commodity
bundles according to the amount of utility obtained from them. In other words, the consumer has
different preferences over the different combinations of goods defined by the set of commodity
bundles.
In order to develop a model we need to make some assumptions about the consumer’s
preferences . There are four assumptions. The first is decisiveness. Here, given any two
commodity bundles in commodity space, the consumer must be able to rank them. In Figure 1,
suppose we randomly chose two commodity bundles A and B. This assumption means that the
consumer must be able to say that they prefer commodity bundle A over B, or B over A, or that
bundles A and B provide the same level of utility