Axioms - consumer choice involving risk, Microeconomics

Axioms:

It is possible to construct a utility index which can be used to predict choice in uncertain situations if the consumer conforms to the following five axioms: 

Axiom of Complete-ordering: For the two alternatives A and B one of the following must be true: the consumer prefers A to B, she prefers B to A, or she is indifferent between them. The consumer's evaluation of alternatives is transitive: if she prefers A to B and B to C, she prefers A to C. 

Axiom of Continuity: Assume that A is preferred to B and B to C. The axiom asserts that there exists some probability P, 0

Axiom of Independence: Assume that the consumer is indifferent between A and B and that C is any outcome whatever. If one lottery ticket L1 offers outcome A and C with probability P and 1-P respectively and another L2 the outcomes B and C with the same probabilities P and 1-P, the consumer is indifferent between the two lottery tickets. Similarly, if she prefers A to B, she will prefer L1 to L2.

Axiom of Unequal-probability: Assume that the consumer prefers A to B. Let L1 = (P1, A, B) and L2 = (P2, A, B). The consumer will prefer L2 to L1 if and only if P2>P1

Axiom of Compound-lottery: Let L1 = (P1, A, B), and L2 = (P2, L3, L4), where L3 = (P3, A, B) and L4 = (P4, A, B), be a compound lottery in which the prizes are lottery tickets. L2 is equivalent to L1 if P1 = P2P3 + (1-P2) P4. Given L2 the probability of obtaining L3 is P2. Consequently, the probability of obtaining A through L2 is P2P3. Similarly, the probability of obtaining L4 is (1-P2), and the probability of obtaining A through L4 is (1-P2) P4. The probability of obtaining A with L2 is the sum of the two probabilities. The consumer evaluates lottery tickets only in terms of the probabilities of obtaining the prizes, and not in terms of how many times she is exposed to a chance mechanism.   

These axioms are very general in nature, and it may be difficult to object to them on the grounds that they place unreasonable restrictions upon the consumer's behaviour. However, they rule out some types of plausible behaviour. Consider a person who derives satisfaction from the share of gambling. It is conceivable that there exists no P other than P=1 or P=0 for such a person, so that she is indifferent between outcome B with certainty and the uncertain prospect consisting of A and C; she will always prefer the "sure thing" to the dubious prospect. This type of behaviour is ruled out by the continuity axiom and the compound lottery axiom.  

Posted Date: 10/26/2012 4:05:34 AM | Location : United States







Related Discussions:- Axioms - consumer choice involving risk, Assignment Help, Ask Question on Axioms - consumer choice involving risk, Get Answer, Expert's Help, Axioms - consumer choice involving risk Discussions

Write discussion on Axioms - consumer choice involving risk
Your posts are moderated
Related Questions
Income Elasticity of Demand is described below: Income elasticity of demand is the percentage change in the quantity demanded/required with respect to the percentage change in

If a minimum wage were imposed below the competitive equilibrium what would we expect to observe in the effected labor markets?

Ask question how do I find the Price

What is significance of methodological economics...



Term Paper: A final paper that focuses on the course content, applied in the setting of your current or past employer, will be due in Module. In this paper you will focus on the fo

Q. Food purchases are relatively price inelastic since food is a necessity. If food is so required for life, how will we explain the heavy advertising of food items at the

meaning, scope, nature

Households: The fundamental unit of individual economic behaviour. Households offer labour supply to labour market, make consumer purchases,earn income (from employment and other s