Preference (economics)

In 1926, Ragnar Frisch was the first to develop a mathematical model of preferences in the context of economic demand and utility functions.[8] Up to then, economists had used an elaborate 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 to relate theoretical concepts to observables.[9] 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 they needed a more empirical structure. Because binary choices are directly observable, they instantly appeal to economists. The search for observables in microeconomics is taken even further by the revealed preference theory, which holds consumers' preferences can be revealed by what they purchase under different circumstances, particularly under different income and price circumstances.[10]

Despite utilitarianism and decision theory, many economists have differing definitions of what a rational agent is. In the 18th century, utilitarianism gave insight into the utility-maximizing versions of rationality; however, economists still have no consistent definition or understanding of what preferences and rational actors should be analyzed.[11]

Since the pioneer efforts of Frisch in the 1920s, the representability of a preference structure with a real-valued function is one of the major issues pervading the theory of preferences. This has been achieved by mapping it to the mathematical index called utility. Von Neumann and Morgenstern's 1944 book "Games and Economic Behavior" treated preferences as a formal relation whose properties can be stated axiomatically. These types 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".[12]

Gérard 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, moving 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 conditions on the preference structure to be formulated and investigated.

Another historical turning point 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 isomorphic 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 having weakly ordered preferences.[13]

Historically, preference in economics as a form of utility can be categorized as ordinal or cardinal data. Both introduced in the 20th century, cardinal and ordinal utility take opposing theories and mindsets in applying and analyzing preference in utility. Vilfredo Pareto introduced the concept of ordinal utility, while Carl Menger led the idea of cardinal utility. Ordinal utility, in summation, is the direct following of preference, where an optimal choice is taken over a set of parameters. A person is expected to act in their best interests and dedicate their preference to the outcome with the greatest utility. Ordinal utility assumes that an individual will not have the same utility from a preference as any other individual because they likely will not experience the same parameters which cause them to decide a given outcome. Cardinal utility is a function of utility where a person makes a decision based on a preference, and the preference decision is weighted based on a quantitative value of utility. This utility unit is assumed to be universally applicable and constant across all individuals. Cardinal utility also assumes consistency across individuals' decision-making processes, assuming all individuals will have the same preference, with all variables held constant. Marshall found that "a good deal of the analysis of consumer behavior could be greatly simplified by assuming that the marginal utility of income is constant" (Robert H. Strotz.[14]), however, this cannot be held to the utility of resources and decision-making applied to income. Ordinal and cardinal utility theories provide unique viewpoints on utility, can be used differently to model decision-making preferences and utilization development, and can be used across many applications for economic analysis.

There are two fundamental comparative value concepts, namely strict preference (better) and indifference (equal in value to).[15] These two concepts are expressed in terms of an agent's best wishes; however, they also express objective or intersubjective valid superiority that does not coincide with the pattern of wishes of any person.

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

The symbol ${\displaystyle \sim }$ is used as a shorthand to denote an indifference relation: ${\displaystyle x\sim y\iff (x\preceq y\land y\preceq x)}$, which reads "the agent is indifferent between y and x", meaning the agent receives the same level of benefit from each.

The symbol ${\displaystyle \prec }$ is used as a shorthand to the strong preference relation: ${\displaystyle x\prec y\iff (x\preceq y\land y\not \preceq x)}$), it is redundant inasmuch as the completeness axiom implies it already.[16]

Non-satiation of Preferences

A simple example of non-satiated preference, in which a large number of oranges are preferred to a single orange.

Non-satiation refers to the belief any commodity bundle with at least as much of one good and more of the other must provide a higher utility, showing that more is always regarded as "better". This assumption is believed to hold as when consumers are able to discard excess goods at no cost, then consumers can be no worse off with extra goods.[17] This assumption does not preclude diminishing marginal utility.

Example

Option A

• Apple = 5
• Orange = 3
• Banana = 2

Option B

• Apple = 6
• Orange = 4
• Banana = 2

In this situation, utility from Option B > A, as it contains more apples and oranges with bananas being constant.

In economics, a utility function is often used to represent a preference structure such that ${\displaystyle u\left(A\right)\geqslant u\left(B\right)}$ if and only if ${\displaystyle A\succsim B}$. 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, 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 different meanings depending on the author's taste, there has been an abuse of semantics in the literature.[19]

According to Simon Board, a continuous utility function always exists if ${\displaystyle \succsim }$ is a continuous rational preference relation on ${\displaystyle R^{n}}$.[29] 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 the budget constraints consumers face. These determine the feasible bundles (which they can afford). According to the standard theory, consumers choose a bundle within their budget such that no other feasible bundle is preferred over it, thus maximizing their utility.

• An increasing utility function is associated with a monotonic preference relation.
• Quasi-concave utility functions are associated with a convex preference order. When non-convex preferences arise, the Shapley–Folkman lemma is applicable.

The possibility of defining a strict preference relation ${\displaystyle \succ }$ as distinguished from the weaker one ${\displaystyle \succsim }$, and vice versa, suggests in principle an alternative approach of starting with the strict relation ${\displaystyle \succ }$ 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.[8] The conditions to avoid such inconsistencies were studied in detail by Andranik Tangian.[30] According to Kreps "beginning with strict preference makes it easier to discuss non-comparability possibilities".[32]

The mathematical foundations of most common types of preferences — that are representable by quadratic or additive utility functions — laid down by Gérard Debreu[33][34] enabled Andranik Tangian to develop methods for their elicitation. In particular, additive and quadratic preference functions in ${\displaystyle n}$ variables can be constructed from interviews, where questions are aimed at tracing totally ${\displaystyle n}$ 2D-indifference curves in ${\displaystyle n-1}$ coordinate planes.[35][36]

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 assumption, one's preferences cannot be represented as maximization of utility.[37]

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

The non-satiation of preferences is another topic that generates debate since it essentially states that "more is better than less." Many argue that this interpretation is flawed and highly subjective. Many critics call for a specification of preference to be able to interpret the non-satiation principle reasonably.[38] For example, in cases where there is a choice between more pollution and less pollution, consumers would rationally prefer less pollution thus making the non-satiation principle fail. Similar conflicts with the principle can be seen in choices that involve bulky goods in a limited space, such as an excess of furniture in a small house.

The concept of transitivity is highly debated, with many examples suggesting that it does not generally hold. One of the most well-known is the Sorites paradox, which shows that indifference between small changes in value can be incrementally extended to indifference between large changes in values.[39]

Another criticism comes from philosophy. Philosophers cast doubt that when most consumers share the same preference in the same market, which may lead to the result that the shared preference has become somewhat objective, whether the judgments of preferences for each individual will still depend on subjectivity or not.