ECON 5020

Microeconomic Theory

Lecture 2: Preference and Choice

1 Introduction
Consider a consumer with endowment

! = (! 1 ; ! 2 ; : : : ; ! L ) > 0

in a competitive pure exchange economy consisting of L goods with prices

p = (p1 ; p2 ; :::; pL ) >> 0:

How does he make a choice? From where? Of course, from his budget (or feasible) set

L
P
L P
L
B (p; w) = x 2 R+ :p x= p i xi w=p != pi ! i :
i=1 i=1

The above is just from the consumption point of view. More generally, given a set of
alternatives B; and suppose the agent can pick up one and only one element from B. Now,
two questions should be asked from the positive and normative points of view, respectively:

Question 1 (Normative perspective) Which element of B the agent should pick up?

Question 2 (Positive perspective) Which element of B the agent will pick up?

There are two approaches to studying consumer’s choice. One is from preference-based
approach (normative approach, utility-based approach), the other is from choice-based
approach (positive approach, behavior approach).
Next, we will talk about the two approaches one by one.

2 The Two Approaches

Preference-based Approach

For this approach, we assume that:

Each agent knows his own preference (taste) correctly.

1
That is, you know yourself! (Do you know yourself correctly? I doubt. On the one
hand, however, we have to make assumption if we use preference-based approach;
On the other hand, in general, no body knows you better than yourself!)
If he makes choice based on his preference, which element he should pick up from the
given alternative set B? That is easy, just pick up the one he likes it most based on his taste.

8
>
> Advantages: Easy to understand
<
Preference-based Approach
>
> The choices from this approach are
: Disadvantages:
imaginational, but not observable

Choice-based Approach

But remember here it is assumed that you know yourself fully! The question is that do
you know yourself fully? I doubt. If yes, you should not be here since you know what you
should do exactly!
What you have known yourself is your history! That is, what we know about you is your
choice you made in the past years.
Next, we will introduce another approach –the choice-based approach or behavior-based
approach (from positive perspective).
Given a set of alternatives B; suppose you just pick up one element from B; denoted by
C (B).
8
>
> The choices from this approach are not imaginational,
>
> Advantages:
< but your true choices. Therefore observable
Choice-based Approach
>
>
>
> Can observe ONLY the past choices
: Disadvantages:
cannot make any prediction

Next, we will introduce them one by one in more detail.

3 Preference-based Approach
How to describe one person? We need to know two things: What he owns and what
kind of person he is. What he has is his endowment, denoted by

! = (! 1 ; ! 2 ; ::::; ! L ) 2 RL+ :

To describe what kind of person he is, we have to borrow some tools from mathematics.
Given a set of alteratives X; where X can be anything. For example,

X = Consumption set RL+

2
or 8 9
>
> go to law school, >
>
< =
go to graduate school and study economics,
X= :
>
> go to business school, ... , >
>
: ;
become a rock star
Next we use a preference relation on X to represent what kind of person he is. What is
a preference relation ? From the economics point of view, for two elements x; y 2 X;

x y () the agent prefers x to y or x is preferred to y

In other words, element x is at least as good as element y to the agent.

x y () the agent strictly prefers x to y:

In other words, element x is at least as good as element y; but y is not at least as good as
element x to the agent. Put it in another way, x is better than y. Thus, we have:

x y () x y; but y x:

Similarly
x y () x y and y x:
In other words, element x is at least as good as element y; and y is at least as good as
element x to the agent as well.
It is noted that

1. The preference relation is subjective. In other words, one person has himself taste
or preference relation.

2. is unique for an agent. That is, from the moment he came to the earth, his taste
or preference relation is given and will never be changed! There is a famous Chinese
saying: Rivers and mountains may be changed, but man’s nature is hard to
change!

3. You could change your beliefs (updating by using the Bayesian rule) after getting some
new information, but not your taste on the set of alternatives.

4. The assumption that the agent has a preference relation demands to much. If you
know your preference relation , you know yourself completely.

Next is one of the key concepts:

De…nition 1 Say that one agent is rational if

1. is complete in the sense if for any two bundles x and y, either x y or y x; and

3
 2. is transitive in the sense if x y and y z imply x z.
What do the two assumptions mean? And why do we need them?
Completeness means that for any two consumption bundles x and y, the agent can tell
the di¤erence.
If completeness is not satis…ed, what would happen?
For example, suppose there are only two consumption bundles x and y in your feasible
budget set and you don’t know which one of x and y is better. Which one would you like
to pick up? Of course, you have no idea! Therefore, to make a choice at any situation, we
have to make completeness assumption.
How about transitivity? If it is not satis…ed, what would happen?
We can prove if you are not transitive, you would go bankrupt almost immediately. Here
is an example. Suppose you prefer x to y and prefer y to z, but prefer z to x. That is, x y
and y z, but z x.
Suppose you own x and I own y and z at the beginning:
Step 1: I ask you: Would you like to exchange your x for my z and pay me a cent? Of
course, you would say yes, since you prefer z to x.
Step 2: After the …rst round trading, now you have z and I have x and y. I will ask then:
Would you like to exchange your z for my y and pay me another cent? Of course, you
would say yes, since you prefer y to z.
Step 3: After the second round trading, now you own y and I own x and z. Then I will
ask: Would you like to exchange your y for my x and pay me just one more cent? Of
course, you would say yes, since you prefer x to y.
After three round trading, you have your original holding x, but have lost three cents
already. If we repeat this trading again and over again, you just lose money and would go
bankrupt very soon. To make your decision to be consistent, we have to make transitivity
assumption.
Suppose one agent is rational with the preference relation . Let X be a set of alternatives
and let
B X
a subset of X:
Please remember that at a particular situation, you can make a choice only from some
elements of X. And this is why we pick up a subset B from X. For example, you can take
ECON 5020, 5021 or 5022, not ECON 6000. But next year, you will take ECON 6000 course.
How does the agent make a choice from the given subset B? In other words, which one
of B he should pick up? That is easy. Just pick up the one he likes it most. Put it another
way,
C (B; ) = fx 2 B : x y for any y 2 Bg :
Is C (B; ) 6= ?? In other words, does he always have an optimal choice?
Next is an example.

4
Example 1 Let B = ($0; $1) and you are the more the better person. That is, you pick up
any amount money from the open interval (0; 1) : Do you have have an optimal amount x?
Very unfortunately, you have no solution. That is,
C (B; ) = ?:
This example tells us that the agent may have no optimal choice even he knows himself
completely and he is rational.
Example 2 Let
B = f(one unit of apple, zero unit of banana) ; (zero unit of apple, one unit of banana)g
and you are indi¤erent between apple and banana. Thus
C (B; ) = B:
This example tells us that the agent may have multiple optimal choices. Thus, for
preference-based approach,
1. C (B; ) could be empty. This is not good since there are no optimal choices!
2. C (B; ) could be multi-valued. This is …ne since there are some optimal choices!
In general, for preference-based approach, the agent just picks up the element(s) from B
maximizing his wellbeing,

max : (1)
x2B

Can we use calculus to get the solution(s) to (1)? Can we use the …rst order conditions
to …nd possible solutions to problem (1)? Can we use the second order conditions to verify
a stationary point to be a solution to problem (1)? Do we have
Z
@
or dx?
dx
No.
To use calculus, we have to transform preference relation or taste into a function f ,
since we only have Z
@f (x)
or f (x) dx:
dx
And this is where utility function comes in:
De…nition 2 For a given preference relation de…ned on a set of alternative set X, say
function u : X ! R1 is a utility function representing if
x y () u(x) > u(y) and
x y () u(x) = u(y):

5
 For utility function, we have some comments:

Existence of utility function for any preference: For any given preference relation ,
does there always exist a utility function u(x) to represent ?

Unfortunately, the answer is “no.” For example, is not rational.

Existence of utility function for rational preference: Given a rational preference

relation , does there always exist a utility function u(x) to represent ?

Unfortunately again, the answer is “no.” There is a famous example –the lexicographic
preference having no any utility functions to represent it. We will talk about this in Chapter
3.

Utility function and rationality: Suppose you have a utility function representing your
preference relation . Are you rational?

The answer is yes. Here is the proof:

Proof. Let u be a utility function representing your preference relation : To prove
to be rational. We just need to prove to be complete and transitive.
For completeness: For any two elements x; y 2 X; we must have either
u (x) u (y)
or
u (x) u (y) :
By the de…nition of utility function, we have either
x y (if u (x) u (y))
or
x y (if u (x) u (y)):
For transitivity: For any three elements x; y; z with
x y and y z
which imply

u (x) u (y) and u (y) u (z) :

Therefore,
u (x) u (z) :
Again by the de…nition of utility function, we have
x z:

6
 Preference and utility function: For what kinds of preference relations , there exist
utility functions representing them?

Next, we introduce a very important result on utility existence:

Theorem 1 (Debreu, 1950s) Under some conditions on X and (to be speci…ed in Chapter
3), then there exists a utility function u(x) representing .

The number of utility functions: Suppose there exists one utility function u represent-
ing . Do there exist other utility functions representing the same ?

For example, how about

2u; u + 100; u 100?
Yes. Actually, any strictly increasing transformation f (u) of u is also a utility function.
Proof. x y () u(x) u(y) () f (u(x)) f (u(y)):
How about
100u?
No!
Thus, for a given rational preference relation , there are only two possibilities: either
there is no utility function or there are an in…nite number of utility functions to represent
it.

Equivalence of utility functions: From the above note, we know if one agent has one
utility, then he has an in…nite number of utility functions representing the same pref-
erence . The question is: Which one of them should be used?

The answer is “any one can be used”and they are all equivalent in the following sense
arg max u (x) = arg max f (u (x))
x2B x2B

for any strictly increasing functions f:

It is only the ranking of alternatives that matters. Properties of utility functions
that are invariant for any strictly increasing transformation are called ordinal.
Cardinal properties are those not preserved under all such transformations. Thus,
the preference relation associated with a utility function is an ordinal property.

Comparison of two agents’utility functions: Two agents A and B:

Agent A with utility function uA (x) = 1000x
and
Agent B with utility function uB (x) = 0:0001x:
Suppose you have one extra dollar. Which one of the two agents should have this one
dollar? A or B?

7
 No idea. That means that utility function is subjective and the two agents’ utilities
cannot be compared.

Necessity of utility function: To study economics, do we have to introduce utility

functions? Otherwise, nothing we can do?

Similarly, do we have to introduce calculus to study science?

No. De…nitely not. But why do we introduce utility function in economics and why do
we introduce calculus in mathematics? Both utility function and calculus are just two good
tools. But very useful and e¢ cient tools. And this is why we introduce them.
Now, suppose one agent has a utility function representing his preference relation and
a subset B of alternative set X? Which one should he pick it up from B? That is easy. Just
solve the following utility maximization problem (UMP)

max u(x)
(2)
s.t. x 2 B

and denote
C (B; ) = fx 2 B : u (x) u (y) for any y 2 Bg :
We call it
Preference-based or Utility-based approach!

4 Choice-based Approach
As we mentioned earlier, preference (utility function) is not observable. What we have
observed are agents’ choices. For example, take ECON 5020, buy one iPhone and so on.
Next, we will introduce the next approach

Choice-based or Behavior-based approach.

Given a subset B of X; ask the agent to pick up one and only one element from B (Please
remember we don’t know why he picks up this one!). The agent’s choice is denoted by

C (B)

(please don’t be confused with C ( ; B) since we don’s assume he has or knows his preference
relation .)
It is noted that

1. C (B) 6= ?: Non empty. It is di¤erent from preference-based approach!

2. C (B) still could be multi-valued. If both x and y are in C (B) ; then the two elements
are the same to the agent.

8
 This time, the agent picks C (B) up from B when B is available; next time the agent
picks C (B 0 ) up from B 0 if B 0 is available; :::; and so on. Put all them together, we have the
choice structure
(X; B; C ( ))
where
B = fB Xg :
Sometimes we also call or use (B; C ( )) as the choice structure.
Next, we will see some examples.

Example 3 Let
X = fx; y; zg
and
B = ffx; yg ; fx; y; zgg
containing two elements.
The choice rule is de…ned as follows:

C1 (fx; yg) = fxg and

C1 (fx; y; zg) = fxg :

What do they mean: C1 (fx; yg) = fxg implies that x is better than y; and C1 (fx; y; zg) =
fxg implies that x is better than both y and z:
How about y; z? In other words, which one of y; z does he prefer? No idea from his choice
or behavior or the current available information. In other words,

C1 (fy; zg) =?

No idea since the choice rule does not specify this.

Example 4 Let X and B be the same as the above example 3, but the new choice rule is
the following

C2 (fx; yg) = fxg and

C2 (fx; y; zg) = fx; yg :

What do they mean: C2 (fx; yg) = fxg implies that x is better than y; and C2 (fx; y; zg) =
fx; yg implies 1. x and y are the same to the agent and 2. both x and y are better than z:
From choice rule C2 ; we can see something wrong since he is not consistent. When he is
facing fx; yg ; he is very sure that x is better than y; however, when he is facing fx; y; zg ;
he is very sure that x and y are indi¤erent! Something inconsistent!

To avoid this inconsistence, we need to impose something on the agent’s behavior or

choice rule. Before introducing the something, we see one more example.

9
Example 5 Let X and B be the same as example 3, but the new choice rule is the following

C3 (fx; yg) = fx; yg and

C3 (fx; y; zg) = fx; yg :

What do they mean: C3 (fx; yg) = fx; yg implies that x and y are the same to the agent;
and C3 (fx; y; zg) = fx; yg implies 1. x and y are the same to the agent and 2. both x and
y are better than z:
Is there anything wrong? In other words, is there anything inconsistent? No.

For choice-based or behavior-based approach, please remember 1: we don’t know why

the agent makes such choices and 2: Maybe the agent himself also doesn’t know why he
made such choices. Since those choices are from positive perspective, but not from
normative perspective, we don’t ask the reasons or we don’t know the reasons.
After observing the agent’s some choices or behavior, what can we learn about the agent?
In other words, what can we say about the person’s nature or the taste or preference relation
from observing his choice or behavior?
Thus, there are “two persons” about the same agent: One is the true person, the
other is the one we have learnt from his choices.
Have you had the experience: Some old people, most of them are blind, standing on the
corner of street, claim they are fortune tellers and try to predict your future when you
pass by them? They usually asked you so many questions. For example, your birthday, your
job, and so on. Do you know why? They just try to learn about you from your choices.
We use to represent the true agent, and use to represent the person we have learnt
from his choices (X; B; C ( )) : This leads us to de…ne

De…nition 3 Given a choice structure (X; B; C( )); the revealed preference relation is
de…ned by

x y if there is a subset B 2 B such that x; y 2 B and x 2 C(B):

Similarly,

x y if there is a subset B 2 B such that x; y 2 B and x 2 C(B); but y 2

= C(B);

and

x y if there is a subset B 2 B such that x; y 2 B and x 2 C(B); and y 2 C(B):

We read 1. x y as “x is revealed at least as good as y”or “x is revealed preferred to

y:”
2. x y as “x is revealed better than y”or “x is revealed strictly preferred to y:”
3. x y as “x is revealed as the same as y”or “x is revealed indi¤erent to y:”
It is noted that the revealed preference relation need not be either complete or tran-
sitive since the agent’s choices maybe very limited.

10
 Next, we will talk about the condition that should be imposed on the choice structure
(X; B; C( )) such that the choices are consistent or rational.
For preference-based approach, it is very easy to specify the conditions such that is
consistent or rational (Do you still remember them?); however, for choice-based ap-
proach, it is not easy. A nature idea is to specify the conditions on the revealed preference
relation , however as we mentioned before, the revealed preference relation is not nec-
essary to be complete since the choices may be very limited. Thus, we have to use the notion
introduced by Paul Samuelson, who is the …rst economist in the US getting the Nobel prize.
Given two subsets B and B 0 of X; and two elements x; y

satisfy:
1. fx; yg B \ B 0 . That is, x and y are available in B and B 0 :
2. x 2 C (B) \ B 0 . That is, if B is o¤ered to him, x is one of his choices though y is also
feasible. Please note that we don’t know if y is also one of his choices since this is not
speci…ed.
3. y 2 B \ C (B 0 ) : That is, if B 0 is o¤ered to him, y is one of his choices though x is also
feasible. Please note that we don’t know if x is also one of his choices since this is not
speci…ed.
Now, if the agent is “rational”a little bit, what conditions his choices or behavior should
satisfy?
From fx; yg B and x 2 C (B) \ B 0 ; x is revealed preferred to y: That is,
x y:

11
From fx; yg B 0 and y 2 B \ C (B 0 ) ; y is revealed preferred to x: That is,

y x:

Thus, if the agent is consistent or rational a little bit, we must have

x y:

That is, under the above three conditions,

not only x 2 C (B) ; but also x 2 C (B 0 )

not only y 2 C (B 0 ) ; but also y 2 C (B) :

Thus suggests us to de…ne

De…nition 4 Given the choice structure (X; B; C( )); say it satis…es the weak axiom (WA)
if the following property holds:
For any two given sets B 2 B and B 0 2 B and any two elements x 6= y; if

1. fx; yg B \ B0;

2. x 2 C(B); and

3. y 2 C(B 0 );
then we must also have both x 2 C(B 0 ) and y 2 C(B):

In other words, WA is not satis…ed if the above three conditions do not imply the con-
clusions. That is:
WA is not satis…ed if there are B; B 0 and x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) such that one
of the following three is true

1.
= C (B 0 ) and y 2
x2 = C (B) ;

2.
= C (B 0 ) and y 2 C (B) ;
x2

3.
x 2 C (B 0 ) and y 2
= C (B) :

Putting all the above together, we have

Theorem 2 For any choice structure (X; B; C( )); the following two conditions are equiva-
lent

12
 1. WA is satis…ed. That is,

x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) =) x 2 C (B 0 ) ; y 2 C (B) :

2. For any B and B 0 , there are no x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) such that

(a)
= C (B 0 ) and y 2
x2 = C (B) ; and
(b)
= C (B 0 ) and y 2 C (B) ; and
x2
(c)
x 2 C (B 0 ) and y 2
= C (B) :

Can we use the revealed preference relation to check if WA is satis…ed or not?

In other words,

1: The choice structure (X; B; C( )) satis…es the weak axiom if the revealed
preference relation satis…es ....

2: The choice structure (X; B; C( )) does not satisfy the weak axiom if the re-
vealed preference relation satis…es ....

First, we try to reexpress the de…nition of WA: By using the revealed preference relation
, the conditions x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) can be reexpressed as

x y and x y:

Similarly, by using the revealed preference relation , the conclusions x 2 C (B 0 ) and

y 2 C (B) can be reexpressed as

x y and y x:

Put them together, we have

Claim 3 Choice structure (X; B; C( )) satis…es the weak axiom (WA) if

x y and y x =) x y;

where is the revealed preference relation .

Next we try the second one:

13
 1: Combining (1) x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) and (2)

= C (B 0 ) and y 2
x2 = C (B)

yields
x y and y x:

2: Combining (1) x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) and (2)

= C (B 0 ) and y 2 C (B)
x2

yields
y x and y x:

3: Combining (1) x 2 C (B) \ B 0 ; y 2 B \ C (B 0 ) and (2)

x 2 C (B 0 ) and y 2
= C (B) :

yields
y x and x y:

Thus, we have:

Claim 4 WA is not satis…ed if there are x and y such that

x y and y x; or

x y and y x; or
y x and y x:

Putting all the above three together, we have

Theorem 5 For any choice structure (X; B; C( )); the following three conditions are equiv-
alent

1. WA is satis…ed;

2. For any x any y;

x y and y x =) x y;
and

3. There are no x any y such that

(a)
x y and y x; and

14
 (b)
x y and y x; and
(c)
y x and y x:

It is noted that WA is the least requirement for an agent’s choices to be consistent. From
the above claims, we can see the WA is really weak since it does not require the revealed
preference to satisfy either completeness or transitivity.
For a given choice structure (X; B; C( )), how to verify if the WA is satis…ed?
There are two methods: One is to use the revealed preference , the other is to use the
de…nition.
Although the de…nition is not easy to use, but understanding it is still very important
since we can see its meaning from pictures.
Next, we discuss all the possibilities by using pictures.
For any two subsets B 2 B and B 0 2 B of X; there are the following …ve possibilities:

Possibility I:
B \ B 0 = ?:
See the picture in this case:

In this case, the WA is automatically satis…ed since there are no such x; y, such that
x 2 C (B) \ B 0 and y 2 B \ C (B 0 ) :
Possibility II:
1: B \ B 0 6= ?; but
2: # (B \ B 0 ) = 1:

15
 See the picture in this case:

In this case, the WA is automatically satis…ed since there are no such x 6= y, fx; yg
B \ B0:

Possibility III:
1: # (B \ B 0 ) 2 plus one of the following
a. C (B) \ B 0 = ? but C (B 0 ) \ B 6= ?
b. C (B 0 ) \ B = ? but C (B) \ B 0 6= ?
c. C (B) \ B 0 = ? and C (B 0 ) \ B = ?:
See the picture in this case:

16
 In this case, the WA is automatically satis…ed since there are no such x 2 C (B) \ B 0
or y 2 B 0 \ C (B) :

Possibility IV:
1: # (B \ B 0 ) 2 and
2. C (B) \ B 0 6= ? and
3. C (B 0 ) \ B 6= ?, but
4. C (B) \ B 0 = C (B 0 ) \ B and
5. # (C (B) \ B 0 ) = # (C (B 0 ) \ B) = 1:
See the picture in this case:

17
 In this case, the WA is automatically satis…ed since there are no such fx; yg C (B) \
B 0 or fx; yg B \ C (B 0 ) :

Possibility V:
1: # (B \ B 0 ) 2 and
2. C (B) \ B 0 6= ? and
3. C (B 0 ) \ B 6= ?, and
4. 9x 6= y such that
(i) x 2 C (B) \ B 0 and
(ii) y 2 B \ C (B 0 ) :

Conclusion I: If either x 2= C (B 0 ) or y 2
= C (B) ; then the WA is not satis…ed.
Conclusion II: If for all such x; y; we have both x 2 C (B 0 ) and y 2 C (B) ; then the WA
is satis…ed.
Thus, to verify if a choice structure (X; B; C( )) satis…es the WA, we only need to check
possibility V since the WA is automatically satis…ed in any other four possibilities.
Next, we will verify if the WA is satis…ed in the above examples.

Example 6 (Example 3 continued).

C1 (B) = C1 (fx; yg) = fxg and

C1 (B 0 ) = C1 (fx; y; zg) = fxg :

Does the choice structure (X; B; C1 ( )) satisfy the WA?

Yes, since there are no pair x 6= y such that x 2 C1 (B) \ B 0 and y 2 B \ C1 (B 0 )
(Possibility IV).

18
 Also we can use the revealed preference to verify this. From C1 (fx; yg) = fxg ; we
conclude
x y;
and from C1 (fx; y; zg) = fxg ; we conclude

x y and x z:

(How about y and z? No idea since the agent has not released this information
to us yet!) Therefore, there are no x and y such that

x y; y x; and x y

Thus, WA is satis…ed.

Example 7 (Example 4 continued).

C2 (B) = C2 (fx; yg) = fxg and

C2 (B 0 ) = C2 (fx; y; zg) = fx; yg :

Does the choice structure (X; B; C2 ( )) satisfy the WA?

This is possibility V since there are a pair x 6= y such that x 2 C2 (B) \ B 0 and y 2
B \ C2 (B 0 ). Though x 2 C2 (B) \ C2 (B 0 ) ; but y 2= C2 (B) \ C2 (B 0 ) : Thus, the WA is not
satis…ed.
Also we can use the revealed preference to verify this. From C2 (fx; yg) = fxg ; we
conclude
x y;
and from C2 (fx; y; zg) = fx; yg ; we conclude

x z; y z and x y

Therefore, there are x and y such that

x y and y x:

Thus, WA is not satis…ed.

Example 8 (Example 5 continued).

C3 (B) = C3 (fx; yg) = fx; yg and

C3 (B 0 ) = C3 (fx; y; zg) = fx; yg :

Does the choice structure (X; B; C3 ( )) satisfy the WA?

This is also possibility V since there are a pair x 6= y such that x 2 C3 (B) \ B 0 and
y 2 B \ C3 (B 0 ). Actually this is the only pair x; y satisfying the above conditions. Since
x 2 C3 (B) \ C3 (B 0 ) ; and y 2 C3 (B) \ C3 (B 0 ) ; thus, the WA is satis…ed.

19
 Also we can use the revealed preference to verify this. From C3 (fx; yg) = fx; yg ; we
conclude
x y;
and from C3 (fx; y; zg) = fx; yg ; we conclude

x y, x z and y z:

Therefore, there are no x and y such that

x y; y x; and x y

Thus, WA is satis…ed.

Next, we will go to the last topic of this lecture (Chapter 1): The relationship between
the two approaches.

Question 3 Given a rational preference relation and let

B = fB : B is a subset of Xg

and
C (B; ) = fx 2 B : x y for any y 2 Bg :
Does the induced choice structure (X; B; C ( ; )) satisfy the WA?

Question 4 Given a choice structure (X; B; C ( )) satisfying the WA. From this choice struc-
ture, we can derive the revealed preference relation . Is the revealed preference relation
rational?

Next, we will try to answer them one by one.

For the …rst question, we have a clear answer.

Claim 6 Suppose the preference relation on the set of alternatives X is rational: If

C (B; ) 6= ? for every subset B 6= ? of X; then the induced choice structure (X; B; C ( ; ))
satis…es the WA.

Proof. Can you imagine why do we need the assumption

C (B; ) 6= ? for any B 6= ??

The reason is that C (B; ) maybe empty even B is nonempty.

Based on the discussion earlier, we only need to consider two sets B and B 0 such that
there is a pair x 6= y with

x 2 C (B; ) \ B 0 and y 2 B \ C (B 0 ; ) :

20
Next we are going to prove that

x 2 C (B 0 ; ) and y 2 C (B; ) :

From fx; yg B and x 2 C (B; ) ; we have

x y:

From fx; yg B and y 2 C (B 0 ; ) ; we have

y x:

Since is rational, we have

y x:
Thus, x 2 C (B; ) \ C (B 0 ; ) : Similarly, we can prove

y 2 C (B; ) \ C (B 0 ; ) :

That is, the WA is satis…ed.

For the second question, we …rst look at an example.

Example 9 Consider
X = fx; y; zg
and
B = ffx; yg ; fy; zg ; fz; xgg
and the choice rule

C4 (fx; yg) = fxg

C4 (fy; zg) = fyg and
C4 (fz; xg) = fzg :

Obviously, the choice structure (X; B; C4 ( )) satis…es the WA since there are no possibility
V. The revealed preference relation is the following:
From C4 (fx; yg) = fxg ; we have
x y;
From C4 (fy; zg) = fyg ; we have
y z;
From C4 (fz; xg) = fzg ; we have
z x:
That is,
x y and y z; but z x:
Thus, the revealed preference relation is not rational since it is not transitive.

21
 From the above example, we can see that: The revealed preference relation is not
necessary to be rational in general given that the WA is satis…ed. That is, the WA is too
weak.
Thus leads us to ask a question next:

Question 5 Given a choice structure (X; B; C ( )) satisfying the WA. Does there exist a
rational preference relation such that the induced choice structure (X; B; C ( ; )) is the
same as (X; B; C ( ))? That is, does there exist a rational preference relation such that

C ( ) = C ( ; )?

Put it another way, does there exists a rational person whose choices or behavior are the
same as the agent C ( )? If yes, how many rational people will do the same job?

This question is very interesting. It leads us to further de…ne

De…nition 5 Given a choice structure (X; B; C( )), say that the choice rule C( ) can be
rationalized if there exists a rational preference relation such that

C(B) = C (B; )

for all B 2 B. That is, generates the choice structure (X; B; C( )).

Some comments here:

1. If yes, we can say that the choice rule C( ) is based on the preference relation .
2. If yes, as though the agent knows himself completely.
3. From Example 9, we can see that a choice structure (X; B; C( )) is not necessary to
be rationalized in general even the WA is satis…ed.
A natural question is: The WA plus what conditions can guarantee (X; B; C( )) to be
rationalized? We have the following result:

Proposition 1 If (X; B; C( )) is a choice structure such that

(i) the weak axiom is satis…ed,

(ii) B includes all subsets of X of up to three elements,

then there is a rational preference relation that rationalizes C( ) relative to B; that is,
C(B) = C (B; ) for all B 2 B. Furthermore, this rational preference relation is the only
preference relation that does so.

22
5 Summary
Given a preference relation on X,

1. If there a utility function representing , then is rational. But the opposite is not
necessary to be true;

2. The induced choice structure (X; B; C ( ; )) does not necessarily satisfy the WA;

3. If is rational, then the induced choice structure (X; B; C ( ; )) satis…es the WA;

4. The revealed preference relation is not necessary to be rational even the choice
structure (X; B; C ( )) satis…es the WA;

5. Preference-based approach
=) C ( ; ) ;

6. Choice-based approach
(X; B; C ( )) =) :

Part I of Assignment 1

1. 1.B.3 (10%) (page 15)

2. 1.C.1 (10%) (page 15)
3. 1.D.1 (10%) (page 15)
4 .1.D.3 (10%) (page 16)
I will give you the whole assignment 1 and specify the due day later.

23