Preference (economics)

In economics and other social sciences, preference is the ordering of alternatives

based on their relative utility, a process which results in an optimal "choice"
(whether real or theoretical). The character of the individual preferences is
determined purely by taste factors, independent of considerations of prices, income,
or availability of goods. A simple example of a preference
order over three goods
With the help of the scientific method many practical decisions of life can be
modelled, resulting in testable predictions about human behavior. Although
economists are usually not interested in the underlying causes of the preferences in themselves, they are interested in the theory of
choice because it serves as a background for empiricaldemand analysis.[1]

Contents
1 History
2 Notation
3 Meaning in decision sciences
3.1 Most commonly used axioms
3.2 Normative interpretations of the axioms
4 Applications to theories of utility
4.1 Primitive equivalents of some known properties of utility functions
4.2 Lexicographic preferences
5 Strict versus weak
6 Aggregation
7 Expected utility theory
8 Criticism
9 See also
10 References

History
In 1926 Ragnar Frisch developed for the first time a mathematical model of preferences in the context of economic demand and
utility functions.[2] Up to then, economists had developed an elaborated theory of demand that omitted primitive characteristics of
people. This omission ceased when, at the end of the 19th and the beginning of the 20th century, logical positivism predicated the
need of theoretical concepts to be related with observables.[3] Whereas economists in the 18th and 19th centuries felt comfortable
theorizing about utility, with the advent of logical positivism in the 20th century, they felt that it needed more of an empirical
structure. Because binary choices are directly observable, it instantly appealed to economists. The search for observables in
microeconomics is taken even further byrevealed preference theory.

Since the pioneer efforts of Frisch in the 1920s, one of the major issues which has pervaded the theory of preferences is the
representability of a preference structure with a real-valued function. This has been achieved by mapping it to the mathematical index
called utility. Von Neumann and Morgenstern 1944 book "Games and Economic Behaviour" treated preferences as a formal relation
whose properties can be stated axiomatically. These type of axiomatic handling of preferences soon began to influence other
economists: Marschak adopted it by 1950, Houthakker employed it in a 1950 paper, and Kenneth Arrow perfected it in his 1951 book
"Social Choice and Individual Values".[4]

Grard Debreu, influenced by the ideas of the Bourbaki group, championed the axiomatization of consumer theory in the 1950s, and
the tools he borrowed from the mathematical field of binary relations have become mainstream since then. Even though the
economics of choice can be examined either at the level of utility functions or at the level of preferences, to move from one to the
other can be useful. For example, shifting the conceptual basis from an abstract preference relation to an abstract utility scale results
in a new mathematical framework, allowing new kinds of conditions on the structure of preference to be formulated and investigated.

Another historical turnpoint can be traced back to 1895, when Georg Cantor proved in a theorem that if a binary relation is linearly
ordered, then it is also isomorphically embeddable in the ordered real numbers. This notion would become very influential for the
theory of preferences in economics: by the 1940s prominent authors such as Paul Samuelson, would theorize about people actually
having weakly ordered preferences.[5]

Notation
Suppose the set of all states of the world is and an agent has a preference relation on . It is common to mark the weak preference
relation by , so that means "the agent wants y at least as much as x" or "the agent weakly prefers y to x".

The symbol is used as a shorthand to the indifference relation: , which reads "the agent is
indifferent between y and x".

The symbol is used as a shorthand to the strong preference relation: , which reads "the agent
strictly prefers y to x".

Meaning in decision sciences

In everyday speech, the statement "x is preferred to y" is generally understood to mean that someone chooses x over y. However,
decision theory rests on more precise definitions of preferences given that there are many experimental conditions influencing
people's choices in many directions.

Suppose a person is confronted with a mental experiment that she must solve with the aid of introspection. She is offered apples (x)
and oranges (y), and is asked to verbally choose one of the two. A decision scientist observing this single event would be inclined to
say that whichever is chosen is the preferred alternative.

Under several repetitions of this experiment (and assuming laboratory conditions controlling outside factors), if the scientist observes
that apples are chosen 51% of the time it would mean that . If half of the time oranges are chosen, then . Finally, if 51%
of the time she chooses oranges it means that . Preference is here being identified with a greater frequency of choice.

This experiment implicitly assumes that the trichotomy property holds for the order relation. Otherwise, out of 100 repetitions, some
of them will give as a result that neither apples, oranges or ties are chosen. These few cases of uncertainty will ruin any preference
information resulting from the frequency attributes of the other valid cases.

However, this example was used for only illustrative purposes, and it should not be interpreted as an indication that the economic
theory of preferences starts with experiments and moves on to theorems. On the contrary
, the method used in the theory preferences is
essentially an armchair method. Economists make assumptions, and from these assumptions they deduce theorems which presumably
can be tested, even though the test is not indispensable.

Consumers are by definition demanders of goods and services. Standard economic theory states that their demand behaviour can be
thought of maximizing a utility index, or its parallel: the ranking of the set of possible consumption bundles by means of either the
binary relation "at least as good as" or the relation "strictly preferred as".
Of all the available bundles of goods and services, only one is ultimately chosen. The theory of preferences examines the problem of
getting to this optimal choice using asystem of preferences within a budgetary limitation.

In reality, people do not necessarily rank or order their preferences in a consistent way. In preference theory, some idealized
conditions are regularly imposed on the preferences of economic actors. One of the most important of these idealized conditions is
the axiom of transitivity:[1]

Axiom of transitivity: If alternative is weakly preferred to alternative , and to , then is weakly preferred to .

Symbolically, this can be stated as

If and then

Sometimes a weaker axiom (that is, it is implied by transitivity, but not vice versa), called "quasi-transitivity" is used, which only
requires the above for strict preferences:

If and then

The language of binary relations allow one to write down exactly what is meant by "ranked set of preferences", and thus gives an
unambiguous definition of order. A preference relation should not be confused with the order relation used to indicate which of
two real numbers is greater.[6] Order relations over the real number line satisfy an extra condition:

and implies

But in preference relations, two things can be equally liked without being in some sense numerically equal. Hence, an indifference
relation is used instead of an equality relation (the symbol denotes this kind of relation). Thus we have

and implies

A system of preferences orpreference structure refers to the set of qualitative relations between dif
ferent alternatives of consumption.
For example, if the alternatives are:

Apple
Orange
Banana
In this example, a preference structure would be:

"The apple is at least as preferred as the orange", and "The orange is as least as preferred as the Banana". One can use to symbolize
that some alternative is "at least as preferred as" another one, which is just a binary relation on the set of alternatives. Therefore:

Apple Orange
Orange Banana

The former qualitative relation can be preserved when mapped into a numerical structure, if we impose certain desirable properties
over the binary relation: these are the axioms of preference order. For instance: Let us take the apple and assign it the arbitrary
number 5. Then take the orange and let us assign it a value lower than 5, since the orange is less preferred than the apple. If this
procedure is extended to the banana, one may prove by induction that if is defined on {apple, orange} and it represents a well-
defined binary relation called "at least as preferred as" on this set, then it can be extended to a function defined on {apple, orange,
banana} and it will represent "at least as preferred as" on this lar
ger set.

Example:

Apple = 5
Orange = 3
Banana = 2
5 > 3 > 2 = u(apple) > u(orange) > u(banana)

and this is consistent with Apple Orange, and with Orange Banana.

Axiom of order (Completeness): For all and we have or or both.

In order for preference theory to be useful mathematically, we need to assume the axiom of continuity. Continuity simply means that
there are no jumps in peoples preferences. In mathematical terms, if we prefer point A along a preference curve to point B, points
very close to A will also be preferred to B. This allows preference curves to be differentiated. The continuity assumption is "stronger
than needed" in the sense that it indeed guarantees the existence of a continuous utility function representation. Continuity is,
therefore, a sufficient condition, but not a necessary one, for a system of preferences.[7]

Although commodity bundles come in discrete packages, economists treat their units as a continuum, because very little is gained
from recognizing their discrete nature. According to Silberber
g, the two approaches are reconcilable by this rhetorical device: When a
consumer makes repeated purchases of a product, the commodity spaces can get converted from the discrete items to the time rates of
consumption. Instead of, say, noting that a consumer purchased one loaf of bread on Monday, another on Friday and another the
following Tuesday, we can speak of an average rate of consumption of bread equal to 7/4 loaves per week. There is no reason why
the average consumption per week cannot be any real number, thus allowing differentiability of the consumer's utility function. We
can speak of continuousservices of goods, even if the goods themselves are purchased in discrete units.

Although some authors includereflexivity as one of the axioms required to obtain representability (this axiom states that ), it is
redundant inasmuch as the completeness axiom implies it .[8]
already

Most commonly used axioms

Order-theoretic: acyclicity, transitivity, the semiorder property, completeness
Topological: continuity, openness or closedness of the preference sets
Linear-space: convexity, homogeneity, translation-invariance

Normative interpretations of the axioms

Everyday experience suggests that people at least talk about their preferences as if they had personal "standards of judgment" capable
of being applied to the particular domain of alternatives that present themselves from time to time.[9] Thus, the axioms are an attempt
to model the decision maker's preferences, not over the actual choice, but over the type of desirable procedure (a procedure that any
human being would like to follow). Behavioral economics investigates inconsistent behavior (i.e. behavior that violates the axioms)
of people. Believing in axioms in a normative way does not imply that everyone is asserted to behave according to them. Instead,
, one that people would like to see themselves orothers following.[3]
they are a basis for suggesting a mode of behavior

Here is an illustrative example of the normative implications of the theory of preferences:[3] Consider a decision maker who needs to
make a choice. Assume that this is a choice of where to live or whom to marry and that the decision maker has asked an economist
for advice. The economist, who wants to engage in normative science, attempts to tell the decision maker how she should make
decisions.

Economist: I suggest that you attach a utility index to each alternative, and choose the alternative with the highest utility
.

Decision Maker: You've been brainwashed. You think only in terms of functions. But this is an important decision, there are people
involved, emotions, these are not functions!

Economist: Would you feel comfortable with cycling among three possible options? Preferring x to y, and then y to z, but then again z
to x?

Decision Maker: No, this is very silly and counterproductive. I told you that there are people involved, and I do not want to play with
their feelings.
Economist: Good. So now let me tell you a secret: if you follow these two conditions making decision, and avoid cycling, then you
can be described as if you are maximizing a utility function.

Consumers whose preference structures violate transitivity would get exposed to being exploited by some unscrupulous person. For
instance, Maria prefers apples to oranges, oranges to bananas, and bananas to apples. Let her be endowed with an apple, which she
can trade in a market. Because she prefers bananas to apples, she is willing to pay, say, one cent to trade her apple for a banana.
Afterwards, Maria is willing to pay another cent to trade her banana for an orange, and again the orange for an apple, and so on.
There are other examples of this kind of irrational behaviour.

Completeness implies that some choice will be made, an assertion that is more philosophically questionable. In most applications, the
set of consumption alternatives is infinite and the consumer is not conscious of all preferences. For example, one does not have to
choose over going on holiday by plane or by train: if one does not have enough money to go on holiday anyway then it is not
necessary to attach a preference order to those alternatives (although it can be nice to dream about what one would do if one would
win the lottery). However, preference can be interpreted as a hypothetical choice that could be made rather than a conscious state of
mind. In this case, completeness amounts to an assumption that the consumers can always make up their mind whether they are
indifferent or prefer one option when presented with any pair of options.

Under some extreme circumstances there is no "rational" choice available. For instance, if asked to choose which one of one's
children will be killed, as in Sophie's Choice, there is no rational way out of it. In that case preferences would be incomplete, since
"not being able to choose" is not the same as "being indif
ferent".

The indifference relation ~ is an equivalence relation. Thus we have a quotient set S/~ of equivalence classes of S, which forms a
partition of S. Each equivalence class is a set of packages that is equally preferred. If there are only two commodities, the equivalence
classes can be graphically represented as indifference curves. Based on the preference relation on S we have a preference relation on
S/~. As opposed to the former, the latter is antisymmetric and a total order.

Applications to theories of utility

In economics, a utility function is often used to represent a preference structure such that if and only if . The
idea is to associate each class of indifference with a real number such that, if one class is preferred to the other, then the number of
the first one is greater than that of the second one. When a preference order is both transitive and complete, then it is standard
practice to call it a rational preference relation, and the people who comply with it are rational agents. A transitive and complete
relation is called a weak order (or total preorder). The literature on preferences is far from being standardized regarding terms such as
complete, partial, strong, and weak. Together with the terms "total", "linear", "strong complete", "quasi-orders", "pre-orders" and
"sub-orders", which also have a different meaning depending on the author's taste, there has been an abuse of semantics in the
literature.[9]

According to Simon Board, acontinuous utility function always exists if is a continuous rational preference relation on .[10] For
any such preference relation, there are many continuous utility functions that represent it. Conversely, every utility function can be
used to construct a unique preference relation.

All the above is independent of the prices of the goods and services and of the budget constraints faced by consumers. These
determine the feasible bundles (which they can afford). According to the standard theory, consumers chooses a bundle within their
budget such that no other feasible bundle is preferred over it; therefore their utility is maximized.

Primitive equivalents of some known properties of utility functions

An increasing utility function is associated with amonotonic preference relation.
Quasi-concave utility functions are associated with aconvex preference order. When non-convex preferences arise,
the ShapleyFolkman lemmais applicable.
Weakly separable utility functions are associated with the weak separability of preferences.
Lexicographic preferences
Lexicographic preferences are a special case of preferences that assign an infinite value to a good, when compared with the other
goods of a bundle.

Strict versus weak

The possibility of defining a strict preference relation as distinguished from the weaker one , and vice versa, suggests in principle
an alternative approach of starting with the strict relation as the primitive concept and deriving the weaker one and the indifference
relation. However, an indifference relation derived this way will generally not be transitive.[2] According to Kreps "beginning with
[11]
strict preference makes it easier to discuss noncomparability possibilities".

Aggregation
Under certain assumptions, individual preferences can be aggregated onto the preferences of a group of people. However, Arrow's
impossibility theorem states that voting systems sometimes cannot convert individual preferences into desirable community-wide acts
of choice.

Expected utility theory

Preference relations were initially applied only to alternatives that involve no risk and uncertainties because this is an assumption of
the homo economicus model of behaviour. Nonetheless, a very similar theory of preferences has also been applied to the space of
simple lotteries, as in expected utility theory. In this case a preference structure over lotteries can also be represented by a utility
function.

Criticism
Some critics say that rational theories of choice and preference theories rely too heavily on the assumption of invariance, which states
that the relation of preference should not depend on the description of the options or on the method of elicitation. But without this
.[12]
assumption, one's preferences cannot be represented as maximization of utility

Milton Friedman said that segregating taste factors from objective factors (i.e. prices, income, availability of goods) is conflicting
because both are "inextricably interwoven".

See also
Behavioral economics
Convex preferences
Economic subjectivism
GibbardSatterthwaite theorem
Lexicographic preferences
Pairwise comparison
Revealed preference
Semiorder
Strict weak ordering
Time preference
Indifference curve
Rational choice theory
Ordinal utility vs. Cardinal utility

References
 1. Arrow, Kenneth (1958). "Utilities, attitudes, choices: a review note". Econometrica. 26 (1): 123. JSTOR 1907381 (htt
ps://www.jstor.org/stable/1907381).
2. Barten, Anton and Volker Bhm. (1982). "Consumer theory", in: Kenneth Arrow and Michael Intrilligator (eds.)
Handbook of mathematical economics. Vol. II, p. 384
3. Gilboa, Itzhak. (2009).Theory of Decision under uncertainty(http://www.econ.hit-u.ac.jp/~kmkj/uncertainty/Gilboa_L
ecture_Notes.pdf). Cambridge: Cambridge university press
4. Moscati, Ivan (2004). "Early Experiments in Consumer Demand Theory"(https://web.archive.org/web/201403021221
47/http://128.118.178.162/eps/mhet/papers/0506/0506003.pdf)(PDF). 128.118.178.162. Wayback Machine.
Archived from the original (http://128.118.178.162/eps/mhet/papers/0506/0506003.pdf)(PDF) on 2014-03-02.
5. Fishburn, Peter (1994). "Utility and subjective probability", in: Robert Aumann and Sergiu Hart (eds).
Handbook of
game theory. Vol. 2. Amsterdam: Elsevier Science. pp. 13971435.
6. Binmore, Ken. (1992).Fun and games. A text on game theory. Lexington: Houghton Mifflin
7. Gallego, Lope (2012). "Policonomics. Economics made simple"(http://www.policonomics.com/preferences/).
Preferences. Open Dictionary. Retrieved 16 March 2013.
8. Mas-Colell, Andreu, Michael Whinston and Jerry Green (1995).Microeconomic theory. Oxford: Oxford University
Press ISBN 0-19-507340-1
9. Shapley, Lloyd and Martin Shubik. (1974). "Game theory in economics". RAND Report R-904/4
10. Board, Simon. "Preferences and Utility"(http://www.econ.ucla.edu/sboard/teaching/econ11_09/econ11_09_lecture2.
pdf) (PDF). UCLA. Retrieved 15 February 2013.
11. Kreps, David. (1990). A Course in Microeconomic Theory. New Jersey: Princeton University Press
12. Slovic, P. (1995). "The Construction of Preference". American Psychologist, ol.
V 50, No. 5, pp. 364371.

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