CHAPTER 4

Utility

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Preferences: A Reminder
x ≻ y: x is preferred strictly to y.
x ~ y: x and y are equally preferred.
x ≿ y: x is preferred at least as much as y.

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Utility Functions – 1
A preference relation that is complete, reflexive, transitive, and continuous can
be represented by a continuous utility function.
Ø Continuity means that small changes to a consumption bundle cause
only small changes to the preference level.

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Utility Functions – 2
A utility function u(x) represents a preference relation if and
only if:

xʹ ≿ xʺ ⇔ u(xʹ) ≥ u(xʺ)

xʹ ≻ xʺ ⇔ u(xʹ) > u(xʺ)

xʹ ~ xʺ ⇔ u(xʹ) = u(xʺ)

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Utility Functions – 3
Utility is an ordinal (i.e. ordering) concept.
Ø E.g., if u(x) = 6 and u(y) = 2 then bundle x is strictly preferred to bundle
y. But x is not preferred three times as much as is y.

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Utility Functions & Indifference Curves – 1
• Consider the bundles (4, 1), (2, 3), and (2, 2).
• Suppose (2, 3) ≻ (4, 1) ~ (2, 2).
• Assign to these bundles any numbers that preserve the preference
ordering; e.g.,
• Call these numbers utility levels.

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Utility Functions & Indifference Curves – 2
• An indifference curve contains equally preferred bundles.
• Equal preference Þ same utility level.
• Therefore, all bundles on an indifference curve have the same utility level.

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Utility Functions & Indifference Curves – 3
• So the bundles (4, 1) and (2, 2) are on the indifference curve with utility
level u = 4.
• But the bundle (2, 3) is on the indifference curve with utility level u = 6.
• In an indifference curve diagram, this preference information looks as
follows:

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Utility Functions & Indifference Curves – 4

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Utility Functions & Indifference Curves – 5
Another way to visualize this same information is to plot the utility level on a
vertical axis.

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Utility Functions & Indifference Curves – 6

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Utility Functions & Indifference Curves – 7
This 3D visualization of preferences can be made more informative by adding
into it the two indifference curves.

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Utility Functions & Indifference Curves – 8

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Utility Functions & Indifference Curves – 9
Comparing more bundles will create a larger collection of all indifference
curves and a better description of the consumer’s preferences.

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Utility Functions & Indifference Curves – 10

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Utility Functions & Indifference Curves – 11
As before, this can be visualized in 3D by plotting each indifference curve at
the height of its utility index.

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Utility Functions & Indifference Curves – 12

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Utility Functions & Indifference Curves – 13
• Comparing all possible consumption bundles gives the complete collection
of the consumer’s indifference curves, each with its assigned utility level.
• This complete collection of indifference curves completely represents the
consumer’s preferences.

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Utility Functions & Indifference Curves – 14
The following eight diagrams illustrate the connection between the two-
dimensional look at utility functions and indifference curves to the three-
dimensional look.

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Utility Functions & Indifference Curves – 15

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Utility Functions & Indifference Curves – 16

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Utility Functions & Indifference Curves – 17

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Utility Functions & Indifference Curves – 18

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Utility Functions & Indifference Curves – 19

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Utility Functions & Indifference Curves – 20

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Utility Functions & Indifference Curves – 21

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Utility Functions & Indifference Curves – 22

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Utility Functions & Indifference Curves – 23
The collection of all indifference curves for a given preference relation is an
“indifference map.”
Ø An indifference map is equivalent to a utility function.

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Utility Functions – 4
There is no unique utility function representation of a preference relation.
Ø Suppose represents a preference relation.
Ø Again consider the bundles (4, 1), (2, 3), and (2, 2).

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Utility Functions – 5

Ø Since
Ø

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Utility Functions – 6

• Define
Ø Then,
Ø So again,
• V preserves the same order as u and therefore represents the
same preferences.

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Utility Functions – 7

• Define
Ø Then,
Ø So again,
W preserves the same order as u and therefore represents the same
preferences.

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Utility Functions – 8
If
• u is a utility function that represents a preference relation
and
• f is a strictly increasing function,
then V = f (u) is also a utility function representing the same preference
relation. This is known as a “monotonic transformation.”

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Goods, Bads, and Neutrals – 1
• A good is a commodity which increases utility with additional consumption.
• A bad is a commodity which decreases utility with additional consumption.
• A neutral is a commodity which does not change utility with additional
consumption.

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Goods, Bads, and Neutrals – 2

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Some Other Utility Functions and Their Indifference Curves – 1
Instead of consider

This utility function is an example of two goods that are perfect substitutes.
What do the indifference curves for this “perfect substitution” utility
function look like?

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Perfect Substitution Indifference Curves – 1

All are linear and parallel.

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Perfect Substitution Indifference Curves – 2
Now, consider squaring the utility function

• Is this a utility function depicting the same preferences?

Now, consider that the consumer would require two units of good 2 to
compensate him for giving up one unit of good 1.
• What is the utility function? (Don’t square it.)
• What is the slope of the indifference curves?

Think about a general form for utility function of perfect substitution preferences!

• What is the slope of an indifference curve? (-a/b) Copyright © 2019 Hal R. Varian
Some Other Utility Functions and Their Indifference Curves – 2
Instead of consider

This utility function is an example of two goods that are perfect complements.
What do the indifference curves for this “perfect complementarity” utility
function look like?

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Perfect-Complementarity Indifference Curves – 1

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Perfect-Complementarity Indifference Curves – 2
Now, consider a consumer who always uses 2 teaspoons of sugar with each cup of
tea.
• What is the utility function?
• Draw an indifference curve to convince yourself!
• What if you multiply the utility function by 2?

Think about a general form for utility function of perfect substitution preferences!

• Draw an indifference curve to convince yourself!

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Some Other Utility Functions and Their Indifference Curves – 3
A utility function of the form is linear in just x2
and is called “quasi-linear.”
ØE.g.,

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Quasi-linear Indifference Curves

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Some Other Utility Functions and Their Indifference Curves – 4
Any utility function of the form with a > 0 and b > 0
is called a “Cobb-Douglas” utility function.
• E.g.,

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Cobb-Douglas Indifference Curves

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Lexicograph
Lexicographic Preference: A is preferred to B if (I) x1(A) > x1(B)
or (ii) x1(A)=x1(B) but x2(A)>x2(B).

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 Lexicographic Function
x2
A is inferior to B

Example: x1 (health)
x2 (money)
for a terminally ill patient

. B

. A

x1
Marginal Utilities – 1
Marginal means “incremental.”
The marginal utility of commodity i is the rate of change of total utility as the
quantity of commodity i consumed changes.
Ø I.e.,

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Marginal Utilities – 2
E.g., if then

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Marginal Utilities and Marginal Rates of Substitution – 1

• The general equation for an indifference curve is

Øk is a constant.
• Totally differentiating this identity gives

Total derivative of a multi-variate function

𝑧 = 𝑓(𝑥, 𝑦)

is

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Marginal Utilities and Marginal Rates of Substitution – 2

can be rearranged algebraically to be:

Ø This is the MRS.

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MU and MRS: An Example – 1
Suppose Then

and

So,

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MU and MRS: An Example – 2

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MRS for Quasi-linear Utility Functions – 1
A quasi-linear utility function is of the form
and

So,

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MRS for Quasi-linear Utility Functions – 2
MRS = −f’ (x1) does not depend upon x2 so the slope of indifference curves for
a quasi-linear utility function is constant along any line for which x1 is
constant. What does that make the indifference map for a quasi-linear utility
function look like?

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MRS for Quasi-linear Utility Functions – 3

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Monotonic Transformations & Marginal Rates of Substitution – 1
As previously discussed, applying a monotonic transformation to a utility
function representing a preference relation simply creates another utility
function representing the same preference relation.
Ø What happens to marginal rates of substitution when a monotonic
transformation is applied?

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Monotonic Transformations & Marginal Rates of Substitution – 2

For the
Create What is the MRS for V?

Ø Which is the same as the MRS for u.

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Monotonic Transformations & Marginal Rates of Substitution – 3
More generally, if V = f (u) where f is a strictly increasing function, then the
MRS is unchanged by this positive monotonic transformation.

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Exercise
Remember Charlie from Chapter 3? Charlie consumes apples and bananas. We had a look at
two of his indifference curves. In this problem we give you enough information so you can
find all of Charlie’s indifference curves. We do this by telling you that Charlie’s utility function
happens to be 𝑈 𝑥! , 𝑥" = 𝑥! 𝑥" .

(a) Charlie has 40 apples and 5 bananas. His utility for the bundle is 𝑈 40,5 = ? The
indifference curve through (40,5) includes all bundles 𝑥! , 𝑥" such that 𝑥! 𝑥" = ? So the
indifference curve through (40,5) has the equation 𝑥" = ?

(a) Donna offers to give Charlie 15 bananas if he will give her 25 apples. Would Charlie have
a bundle that he likes better than (40,5) if he makes this trade? What is the largest
number of apples that Donna could demand from Charlie in return for 15 bananas if she
expects him to be willing to trade or at least indifferent about trading?

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Credits
This concludes the Lecture PowerPoint presentation for Chapter 4 of Intermediate Microeconomics, 9e
For more resources, please visit http://digital.wwnorton.com/intermicro9media.

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