Why and When Preferences Convex? Threshold Effects and Uncertain Quality: February 3rd, 2010

In the LARGE meeting, Yixin presented the paper by Trenton G. Smith and Attila Tasnadi.

The authors discuss the circumstances under which convexity of preferences are beneficial. Particularly, 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), to some extent. However, some of the assumptions used in developing this theory are often violated in real-world problems. Further, the cases discussed in this paper are extremely simple: the consumer only need to make a decision about his/her consumption of two products with respect to a single attribute quality measure. Therefore, the generalizability of the theory to more complicated real-world cases is not clear.

Nevertheless, this paper does add some insights to the existing work on preferences and suggests that we need to rethink when taking the convexity assumption of preferences for granted.