Why and When Preferences Convex? Threshold Effects and Uncertain Quality
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Abstract
| It is often assumed (for analytical convenience, but also in accordance with common intuition) that consumer preferences are convex. In this paper, the authors consider circumstances under which such preferences are (or are not) optimal. In particular, they investigate a setting in which goods possess some hidden quality with known distribution, and the consumer chooses a bundle of goods that maximizes the probability that he receives some threshold level of this quality. It is shown that if the threshold is small relative to consumption levels, preferences will tend to be convex; whereas the opposite holds if the threshold is large. The proposed theory helps explain a broad spectrum of economic behavior (including, in particular, certain common commercial advertising strategies), suggesting that sensitivity to information about thresholds is deeply rooted in human psychology. |
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