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Economics 101A Lecture 05 Revised

This document provides an overview of key concepts in microeconomics including properties of preferences, constructing utility functions from preferences, and common utility function forms. Specifically, it discusses: 1) Properties like monotonicity, strict monotonicity, and convexity of preference relations; 2) How rational and continuous preferences can be represented by a continuous utility function; and 3) Examples of utility functions like Cobb-Douglas, perfect substitutes, perfect complements, and constant elasticity of substitution.

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50 views

Economics 101A Lecture 05 Revised

This document provides an overview of key concepts in microeconomics including properties of preferences, constructing utility functions from preferences, and common utility function forms. Specifically, it discusses: 1) Properties like monotonicity, strict monotonicity, and convexity of preference relations; 2) How rational and continuous preferences can be represented by a continuous utility function; and 3) Examples of utility functions like Cobb-Douglas, perfect substitutes, perfect complements, and constant elasticity of substitution.

Uploaded by

sh4dow.strid3r9581
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Economics 101A

(Lecture 5, Revised)

Stefano DellaVigna

September 9, 2003

Outline

1. Properties of Preferences (continued)

2. From Preferences to Utility (and viceversa)

3. Common Utility Functions

4. (Utility maximization)

Properties of Preferences (ctd)


Indierence relation : x y if x y and y x
Strict preference: x y if x y and not y x
Exercise. If is rational,
is transitive
is transitive
Reflexive property of . For all x, x x.

Other features of preferences


Preference relation is:
monotonic if x y implies x y.

strictly monotonic if x y and xj > yj for


some j implies x y.

convex if for all x, y, and z in X such that x z


and y z, then tx + (1 t)y z for all t in
[0, 1]

From preferences to utility


Nicholson, Ch. 3
Economists like to use utility functions u : X R
u(x) is liking of good x
u(a) > u(b) means: I prefer a to b.
Def. Utility function u represents preferences if,
for all x and y in X, x y if and only if u(x)
u(y).

Theorem. If preference relation is rational and


continuous, there exists a continuous utility function
u : X R that represents it.

2 and strongly monotonic.


Proof for case X = R+

Define u(x) =?
Consider the points in the diagonal, (t, t)
Set {t : (t, t) x} is non-empty by monotonicity
Set {t : x (t, t)} is non-empty by monotonicity
Both sets are closed by continuity
(Connected set X: A X closed, B X
closed, and A B = X = A B non-empty)
By connectedness of R, the two sets have nonempty intersection = tx such that (tx, tx)
x. Define u(x) = tx.

Does u represent ?

x y implies (u(x), u(x)) x y (u(y), u(y)) =


[by transitivity] (u(x), u(x)) (u(y), u(y)) =
[by monotonicity] u(x) u(y)
Similarly can prove other direction (exercise!)
(We do not prove continuity of u(x))

Utility function representing is not unique


Take exp(u(x))
u(a) > u(b) exp(u(a)) > exp(u(b))
If u(x) represents preferences and f is a strictly
increasing function, then f (u(x)) represents as
well.

If preferences are represented from a utility function,


are they rational?
completeness
transitivity

Indierence curves: u(x1, x2) = u

They are just implicit functions! u(x1, x2) u


=0

Ux0 1
dx2
= 0 = M RS
dx1
Ux2
Indierence curves for:
monotonic preferences;

strictly monotonic preferences;

convex preferences

Common utility functions


Nicholson, Ch. 3, pp. 8084

1
x
1. Cobb-Douglas preferences: u(x1, x2) = x
1 2
1
x = x2
M RS = xa1
x
/(1a)x
1 2
1
2
1 x1

2. Perfect substitutes: u (x1, x2) = x1 + x2


M RS = /

3. Perfect complements: u (x1, x2) = min (x1, x2)


M RS discontinuous at x2 =
x1

4. Constant Elasticity of Substitution: u (x1, x2) =

1/
x1 + x2

M RS = xx1
2

if = 1, then...
if = 0, then...
if +, then...

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