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Utility Mapping of Preferences

This document discusses theoretical tools of public finance, specifically consumer preferences and utility. It introduces the concept of indifference curves, which represent combinations of goods that provide the same level of utility. An individual's preferences can be mapped using a utility function that assigns a numerical value of utility to different consumption bundles. The key concept is marginal utility - the additional utility obtained from consuming one more unit of a good. The principle of diminishing marginal utility is that each additional unit of a good provides less additional utility than the previous unit due to saturation effects. An example utility function is provided to illustrate this.

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51 views

Utility Mapping of Preferences

This document discusses theoretical tools of public finance, specifically consumer preferences and utility. It introduces the concept of indifference curves, which represent combinations of goods that provide the same level of utility. An individual's preferences can be mapped using a utility function that assigns a numerical value of utility to different consumption bundles. The key concept is marginal utility - the additional utility obtained from consuming one more unit of a good. The principle of diminishing marginal utility is that each additional unit of a good provides less additional utility than the previous unit due to saturation effects. An example utility function is provided to illustrate this.

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penelopegerhard
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CHAPTER 2 THEORETICAL TOOLS OF PUBLIC FINANCE 29

him for the much colder weather. But he may prefer C to either: the salary in
Washington is higher than in Phoenix and the weather is much better than
in Minneapolis. Compromising on salary and location leaves Sam better off
than choosing an extreme of one or the other in this example.

Utility Mapping of Preferences


Underlying the derivation of indifference curves is the notion that each indi-
vidual has a well-defined utility function. A utility function is some mathemati-
cal representation U f (X1, X 2, X 3, . . .), where X1, X 2, X 3, and so on are the
goods consumed by the individual and f is some mathematical function that
describes how the consumption of those goods translates to utility. This math-
ematical representation allows us to compare the well-being associated with
different levels of goods consumption.
For example, suppose that Andreas utility function over CDs and movies
is U Q C .
Q M With this function, she would be indifferent between
4 CDs and 1 movie, 2 CDs and 2 movies, and 1 CD and 4 movies because
each of these bundles would deliver a utility level of 2. But she would prefer
3 CDs and 3 movies to any of these bundles, since this would give her a utility
level of 3.
Marginal Utility The key concept for understanding consumer preferences is
marginal utility, or the additional increment to utility from consuming an marginal utility The additional
additional unit of a good. This utility function described exhibits the important increment to utility obtained by
consuming an additional unit of
principle of diminishing marginal utility: the consumption of each additional unit a good.
of a good makes an individual less happy than the consumption of the previous
unit. To see this, Figure 2-3 graphs the marginal utility, the increment to utility

FIGURE 2-3

Marginal
utility of Diminishing Marginal Utility
movies, MUM Holding the number of CDs con-
stant at 2, with a utility function of
1.41 U QC
QM , each additional
movie consumed raises utility by
less and less.

0.59

0.45 Marginal
utility
(QC = 2)
0 1st movie 2nd movie 3rd movie Quantity of
movies, QM

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