Theory of Choice
• Basic Model of Choice
The Theory of Choice
Lectures in Microeconomics-Charles W. Upton
The Theory of Choice
Theory of Choice
The Basic Model
• Basic Model of Choice
• Some Simple Illustrations
• Suppose an individual is asked to choose
among the following
The Theory of Choice
The Theory of Choice
The Basic Model
The Basic Model
• Suppose an individual is asked to choose
among the following
Basket “A”
Basket “B”
• Suppose an individual is asked to choose
among the following
Basket “C”
Basket “A”
Basket “B”
3 Apples
2 Apples
1 Apple
2 Bananas
3 Bananas
4 Bananas
3 Apples
2 Apples
1 Apple
2 Bananas
3 Bananas
4 Bananas
Basket “C”
• We make some basic assumptions about
how the choice will be made
The Theory of Choice
The Theory of Choice
1
Assumption of Completeness
• I prefer Basket A to Basket B
The Theory of Choice
Assumption of Completeness
• I prefer Basket A to Basket B
• I prefer Basket B to Basket A
The Theory of Choice
Assumption of Completeness
Assumption of Completeness
• I prefer Basket A to Basket B
• I prefer Basket B to Basket A
• I am indifferent. The two are equally
attractive.
• I prefer Basket A to Basket B
• I prefer Basket B to Basket A
• I am indifferent. The two are equally
attractive.
• I don’t know
• Neither
The Theory of Choice
Assumption of Transitivity
• If A is preferred to B and
• B is preferred to C
• Then A is preferred to C
The Theory of Choice
The Theory of Choice
More is Better than Less
• If Basket A contains more than Basket B,
then A is preferred to B
The Theory of Choice
2
More is Better than Less
• If Basket A contains more than Basket B,
then A is preferred to B
– Basket A: 3 Apples, 2 Bananas
– Basket B: 2 Apples, 2 Bananas
More is Better than Less
• If Basket A contains more than Basket B,
then A is preferred to B
– Basket A: 3 Apples, 2 Bananas
– Basket B: 2 Apples, 2 Bananas
A >B
A >B
The Theory of Choice
The Theory of Choice
Utility Functions
Utility Functions
• The assumptions mean that individuals have
a utility function U(A, B)
• The assumptions mean that individuals have
a utility function U(A, B)
• The function gives the “utility” for different
combinations of (say) apples and bananas
The Theory of Choice
The Theory of Choice
Utility Functions
An Example
• The assumptions mean that individuals have
a utility function U(A, B)
• The function gives the “utility” for different
combinations of (say) apples and bananas
• If U(A1,B1) > U(A2,B2)
(A1,B1) is preferred to (A2,B2)
U= AB
The Theory of Choice
Utility from Different Baskets
Choice Apples
A
B
C
D
4
2
3
3.5
Bananas
1
2
3
4
Units of
Utility
4
4
9
14
The Theory of Choice
3
An Example
An Example
U= AB
U= AB
Utility from Different Baskets
Ch oice Apples
A
B
C
D
Ba n a n a s
4
2
3
3.5
1
2
3
4
Un it s of
Ut ilit y
4
4
9
14
Utility from Different Baskets
Ch oice Apples
A
B
C
D
4
2
3
3.5
The Theory of Choice
An Example
U= AB
U= AB
Utility from Different Baskets
A
B
C
D
4
2
3
3.5
1
2
3
4
Un it s of
Ut ilit y
4
4
9
14
The Theory of Choice
An Example
Ch oice Apples
Ba n a n a s
Ba n a n a s
1
2
3
4
Un it s of
Ut ilit y
4
4
9
14
Utility from Different Baskets
Choice Apples
A
B
C
D
4
2
3
3.5
Bananas
1
2
3
4
Units of
Utility
4
4
9
14
D>C>B=A
The Theory of Choice
The Theory of Choice
Modifying the Example
U= (AB)2
Utility from Different Baskets
Ch oice Apples
A
B
C
D
4
2
3
3.5
Ba n a n a s
1
2
3
4
Un it s of
Ut ilit y
16
16
81
196
Ordinality
• U(Basket A) = 10
• U(Basket B) = 7
D>C>B=A
The Theory of Choice
The Theory of Choice
4
Ordinality
Ordinality
• U(Basket A) = 10
• U(Basket B) = 7
• U(Basket A) = 10
• U(Basket B) = 7
A >B
A >B
Period!
The Theory of Choice
The Theory of Choice
End
©2004 Charles
W. Upton
The Theory of Choice
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