Preference

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In psychology, economics and philosophy, preference is a technical term usually used in relation to choosing between alternatives. For example, someone prefers A over B if they would rather choose A than B. Preferences are central to decision theory because of this relation to behavior. Some methods such as Ordinal Priority Approach use preference relation for decision-making. As connative states, they are closely related to desires. The difference between the two is that desires are directed at one object while preferences concern a comparison between two alternatives, of which one is preferred to the other.

Contents

In insolvency, the term is used to determine which outstanding obligation the insolvent party has to settle first.

Psychology

In psychology, preferences refer to an individual's attitude towards a set of objects, typically reflected in an explicit decision-making process. [1] The term is also used to mean evaluative judgment in the sense of liking or disliking an object, as in Scherer (2005), [2] which is the most typical definition employed in psychology. It does not mean that a preference is necessarily stable over time. Preference can be notably modified by decision-making processes, such as choices, [3] [4] even unconsciously. [5] Consequently, preference can be affected by a person's surroundings and upbringing in terms of geographical location, cultural background, religious beliefs, and education. These factors are found to affect preference as repeated exposure to a certain idea or concept correlates with a positive preference. [6]

Economics

In economics and other social sciences, preference refers to the set of assumptions related to ordering some alternatives, based on the degree of happiness, satisfaction, gratification, morality, enjoyment, or utility they provide. The concept of preferences is used in post-World War II neoclassical economics to provide observable evidence in relation to people's actions. [7] These actions can be described by Rational Choice Theory, where individuals make decisions based on rational preferences which are aligned with their self-interests in order to achieve an optimal outcome. [8]

Consumer preference, or consumers' preference for particular brands over identical products and services, is an important notion in the psychological influence of consumption. Consumer preferences have three properties: completeness, transitivity and non-satiation. For a preference to be rational, it must satisfy the axioms of transitivity and Completeness (statistics). The first axiom of transitivity refers to consistency between preferences, such that if x is preferred to y and y is preferred to z, then x has to be preferred to z. [9] [10] The second axiom of completeness describes that a relationship must exist between two options, such that x must be preferred to y or y must be preferred to x, or is indifferent between them. [9] [10] For example, if I prefer sugar to honey and honey to sweetener then I must prefer sugar to sweetener to satisfy transitivity and I must have a preference between the items to satisfy completeness. Under the axiom of completeness, an individual cannot lack a preference between any two options. [11]

An example of transitive and complete preferences. 279124338 2213 4894807220743277869 n.jpg
An example of transitive and complete preferences.

If preferences are both transitive and complete, the relationship between preference can be described by a utility function. [12] This is because the axioms allow for preferences to be ordered into one equivalent ordering with no preference cycles. [13] Maximising utility does not imply maximise happiness, rather it is an optimisation of the available options based on an individual's preferences. [14] The so-called Expected Utility Theory (EUT), which was introduced by John von Neumann and Oskar Morgenstern in 1944, explains that so long as an agent's preferences over risky options follow a set of axioms, then he is maximizing the expected value of a utility function. [15] In utility theory, preference relates to decision makers' attitudes towards rewards and hazards. The specific varieties are classified into three categories: 1) risk-averse, that is, equal gains and losses, with investors participating when the loss probability is less than 50%; 2) the risk-taking kind, which is the polar opposite of type 1); 3) Relatively risk-neutral, in the sense that the introduction of risk has no clear association with the decision maker's choice. [16]

The mathematical foundations of most common types of preferences — that are representable by quadratic or additive functions — laid down by Gérard Debreu [17] [18] enabled Andranik Tangian to develop methods for their elicitation. In particular, additive and quadratic preference functions in variables can be constructed from interviews, where questions are aimed at tracing totally 2D-indifference curves in coordinate planes without referring to cardinal utility estimates. [19] [20]

Empirical evidence has shown that the usage of rational preferences (and Rational Choice Theory) does not always accurately predict human behaviour because it makes unrealistic assumptions. [21] [22] [23] In response to this, neoclassical economists argue that it provides a normative model for people to adjust and optimise their actions. [24] Behavioural economics describes an alternative approach to predicting human behaviour by using psychological theory which explores deviations from rational preferences and the standard economic model. [25] It also recognises that rational preferences and choices are limited by heuristics and biases. Heuristics are rules of thumb such as elimination by aspects which are used to make decisions rather than maximising the utility function. [26] Economic biases such as reference points and loss aversion also violate the assumption of rational preferences by causing individuals to act irrationally. [27]

Individual preferences can be represented as an indifference curve given the underlying assumptions. Indifference curves graphically depict all product combinations that yield the same amount of usefulness. Indifference curves allow us to graphically define and rank all possible combinations of two commodities. [28]

The graph's three main points are:

  1. If more is better, the indifference curve dips downward.
  2. Greater transitivity indicates that the indifference curves do not overlap.
  3. A propensity for diversity causes indifference curves to curve inward.

Risk preference

Risk preference is defined as how much risk a person is prepared to accept based on the expected utility or pleasure of the outcome.

Risk tolerance is a critical component of personal financial planning, that is, risk preference.

In psychology, risk preference is occasionally characterised as the proclivity to engage in a behaviour or activity that is advantageous but may involve some potential loss, such as substance abuse or criminal action that may bring significant bodily and mental harm to the individual. [29]

In economics, risk preference refers to a proclivity to engage in behaviours or activities that entail greater variance returns, regardless of whether they be gains or losses, and are frequently associated with monetary rewards involving lotteries. [30]

There are two different traditions of measuring preference for risk, the revealed and stated preference traditions, which coexist in psychology, and to some extent in economics as well. [31] [32] [33]

Risk preference evaluated from stated preferences emerges as a concept with significant temporal stability, but revealed preference measures do not. [34]

Relation to desires

Preferences and desires are two closely related notions: they are both conative states that determine our behavior. [35] The difference between the two is that desires are directed at one object while preferences concern a comparison between two alternatives, of which one is preferred to the other. [36] [35] The focus on preferences instead of desires is very common in the field of decision theory. It has been argued that desire is the more fundamental notion and that preferences are to be defined in terms of desires. [37] [36] [35] For this to work, desire has to be understood as involving a degree or intensity. Given this assumption, a preference can be defined as a comparison of two desires. [37] That Nadia prefers tea over coffee, for example, just means that her desire for tea is stronger than her desire for coffee. One argument for this approach is due to considerations of parsimony: a great number of preferences can be derived from a very small number of desires. [37] [35] One objection to this theory is that our introspective access is much more immediate in cases of preferences than in cases of desires. So it is usually much easier for us to know which of two options we prefer than to know the degree with which we desire a particular object. This consideration has been used to suggest that maybe preference, and not desire, is the more fundamental notion. [37]

Insolvency

In Insolvency, the term can be used to describe when a company pays a specific creditor or group of creditors. From doing this, that creditor(s) is made better off, than other creditors. After paying the 'preferred creditor', the company seeks to go into formal insolvency like an administration or liquidation. There must be a desire to make the creditor better off, for them to be a preference. If the preference is proven, legal action can occur. It is a wrongful act of trading. Disqualification is a risk. [38] Preference arises within the context of the principle maintaining that one of the main objectives in the winding up of an insolvent company is to ensure the equal treatment of creditors. [39] The rules on preferences allow paying up their creditors as insolvency looms, but that it must prove that the transaction is a result of ordinary commercial considerations. [39] Also, under the English Insolvency Act 1986, if a creditor was proven to have forced the company to pay, the resulting payment would not be considered a preference since it would not constitute unfairness. [40] It is the decision to give a preference, rather than the giving of the preference pursuant to that decision, which must be influenced by the desire to produce the effect of the preference. For these purposes, therefore, the relevant time is the date of the decision, not the date of giving the preference. [41]

See also

Related Research Articles

<span class="mw-page-title-main">Rational choice models</span> Sociological theory

Rational choice theory refers to a set of guidelines that help understand economic and social behaviour. The theory originated in the eighteenth century and can be traced back to the political economist and philosopher Adam Smith. The theory postulates that an individual will perform a cost–benefit analysis to determine whether an option is right for them. Rational choice theory looks at three concepts: rational actors, self interest and the invisible hand.

In economics, utility is a measure of the satisfaction that a certain person has from a certain state of the world. Over time, the term has been used in at least two different meanings.

<span class="mw-page-title-main">Indifference curve</span> Concept in economics

In economics, an indifference curve connects points on a graph representing different quantities of two goods, points between which a consumer is indifferent. That is, any combinations of two products indicated by the curve will provide the consumer with equal levels of utility, and the consumer has no preference for one combination or bundle of goods over a different combination on the same curve. One can also refer to each point on the indifference curve as rendering the same level of utility (satisfaction) for the consumer. In other words, an indifference curve is the locus of various points showing different combinations of two goods providing equal utility to the consumer. Utility is then a device to represent preferences rather than something from which preferences come. The main use of indifference curves is in the representation of potentially observable demand patterns for individual consumers over commodity bundles.

<span class="mw-page-title-main">Arrow's impossibility theorem</span> Proof all ranked voting rules have spoilers

Arrow's impossibility theorem is a key result in social choice theory, showing that no ranking-based decision rule can satisfy the requirements of rational choice theory. Most notably, Arrow showed that no such rule can satisfy independence of irrelevant alternatives, the principle that a choice between two alternatives A and B should not depend on the quality of some third, unrelated option C.

<span class="mw-page-title-main">Behavioral economics</span> Academic discipline

Behavioral economics is the study of the psychological and cognitive factors involved in the decisions of individuals or institutions, and how these decisions deviate from those implied by traditional economic theory.

<span class="mw-page-title-main">Consumer choice</span> Aspect of economics

The theory of consumer choice is the branch of microeconomics that relates preferences to consumption expenditures and to consumer demand curves. It analyzes how consumers maximize the desirability of their consumption, by maximizing utility subject to a consumer budget constraint. Factors influencing consumers' evaluation of the utility of goods include: income level, cultural factors, product information and physio-psychological factors.

<span class="mw-page-title-main">Welfare economics</span> Use of microeconomic techniques to evaluate well-being at the aggregate level

Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society.

<span class="mw-page-title-main">Decision theory</span> Branch of applied probability theory

Decision theory or the theory of rational choice is a branch of probability, economics, and analytic philosophy that uses the tools of expected utility and probability to model how individuals should behave rationally under uncertainty. It differs from the cognitive and behavioral sciences in that it is prescriptive and concerned with identifying optimal decisions for a rational agent, rather than describing how people really do make decisions. Despite this, the field is extremely important to the study of real human behavior by social scientists, as it lays the foundations for the rational agent models used to mathematically model and analyze individuals in fields such as sociology, economics, criminology, cognitive science, and political science.

The expected utility hypothesis is a foundational assumption in mathematical economics concerning decision making under uncertainty. It postulates that rational agents maximize utility, meaning the subjective desirability of their actions. Rational choice theory, a cornerstone of microeconomics, builds this postulate to model aggregate social behaviour.

In decision theory, economics, and probability theory, the Dutch book arguments are a set of results showing that agents must satisfy the axioms of rational choice to avoid a kind of self-contradiction called a Dutch book. A Dutch book or money pump is a set of bets that ensures a guaranteed loss, i.e. the gambler will lose money no matter what happens. A set of beliefs and preferences is called coherent if it cannot result in a Dutch book.

Utility maximization was first developed by utilitarian philosophers Jeremy Bentham and John Stuart Mill. In microeconomics, the utility maximization problem is the problem consumers face: "How should I spend my money in order to maximize my utility?" It is a type of optimal decision problem. It consists of choosing how much of each available good or service to consume, taking into account a constraint on total spending (income), the prices of the goods and their preferences.

In economics, a cardinal utility expresses not only which of two outcomes is preferred, but also the intensity of preferences, i.e. how much better or worse one outcome is compared to another.

<span class="mw-page-title-main">Social choice theory</span> Academic discipline

Social choice theory is a branch of welfare economics that analyzes methods of combining individual opinions, beliefs, or preferences to reach a collective decision or create measures of social well-being. It contrasts with political science in that it is a normative field that studies how societies should make decisions, whereas political science is descriptive. Social choice incorporates insights from economics, mathematics, philosophy, political science, and game theory to find the best ways to combine individual preferences into a coherent whole, called a social welfare function.

In decision theory, the Ellsberg paradox is a paradox in which people's decisions are inconsistent with subjective expected utility theory. John Maynard Keynes published a version of the paradox in 1921. Daniel Ellsberg popularized the paradox in his 1961 paper, "Risk, Ambiguity, and the Savage Axioms". It is generally taken to be evidence of ambiguity aversion, in which a person tends to prefer choices with quantifiable risks over those with unknown, incalculable risks.

Revealed preference theory, pioneered by economist Paul Anthony Samuelson in 1938, is a method of analyzing choices made by individuals, mostly used for comparing the influence of policies on consumer behavior. Revealed preference models assume that the preferences of consumers can be revealed by their purchasing habits.

The Allais paradox is a choice problem designed by Maurice Allais to show an inconsistency of actual observed choices with the predictions of expected utility theory. The Allais paradox demonstrates that individuals rarely make rational decisions consistently when required to do so immediately. The independence axiom of expected utility theory, which requires that the preferences of an individual should not change when altering two lotteries by equal proportions, was proven to be violated by the paradox.

<span class="mw-page-title-main">Von Neumann–Morgenstern utility theorem</span> Any individual whose preferences satisfy four axioms has a utility function

In decision theory, the von Neumann–Morgenstern (VNM) utility theorem demonstrates that rational choice under uncertainty involves making decisions that take the form of maximizing the expected value of some cardinal utility function. This function is known as the von Neumann–Morgenstern utility function. The theorem forms the foundation of expected utility theory.

In economics, and in other social sciences, preference refers to an order by which an agent, while in search of an "optimal choice", ranks alternatives based on their respective utility. Preferences are evaluations that concern matters of value, in relation to practical reasoning. Individual preferences are determined by taste, need, ..., as opposed to price, availability or personal income. Classical economics assumes that people act in their best (rational) interest. In this context, rationality would dictate that, when given a choice, an individual will select an option that maximizes their self-interest. But preferences are not always transitive, both because real humans are far from always being rational and because in some situations preferences can form cycles, in which case there exists no well-defined optimal choice. An example of this is Efron dice.

<span class="mw-page-title-main">Semiorder</span> Numerical ordering with a margin of error

In order theory, a branch of mathematics, a semiorder is a type of ordering for items with numerical scores, where items with widely differing scores are compared by their scores and where scores within a given margin of error are deemed incomparable. Semiorders were introduced and applied in mathematical psychology by Duncan Luce as a model of human preference. They generalize strict weak orderings, in which items with equal scores may be tied but there is no margin of error. They are a special case of partial orders and of interval orders, and can be characterized among the partial orders by additional axioms, or by two forbidden four-item suborders.

In expected utility theory, a lottery is a discrete distribution of probability on a set of states of nature. The elements of a lottery correspond to the probabilities that each of the states of nature will occur,. Much of the theoretical analysis of choice under uncertainty involves characterizing the available choices in terms of lotteries.

References

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