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Utility Lecture 1

Utility functions provide a numeric way to represent and analyze a person's preferences. A utility function assigns a numeric value, or utility level, to different bundles of goods in a way that preserves the person's preference ordering. Utility functions are unique up to positive monotonic transformations. Indifference curves, which represent combinations of goods that provide equal satisfaction, can be derived from utility functions. The collection of indifference curves corresponding to all possible utility levels completely represents a consumer's preferences.

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17 views33 pages

Utility Lecture 1

Utility functions provide a numeric way to represent and analyze a person's preferences. A utility function assigns a numeric value, or utility level, to different bundles of goods in a way that preserves the person's preference ordering. Utility functions are unique up to positive monotonic transformations. Indifference curves, which represent combinations of goods that provide equal satisfaction, can be derived from utility functions. The collection of indifference curves corresponding to all possible utility levels completely represents a consumer's preferences.

Uploaded by

ntarannum2004
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 PPTX, PDF, TXT or read online on Scribd
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Chap.

UTILITY
Utility Functions

 Utility
• an indicator of person’s overall well-being
• a numeric measure of a person’s happiness
• a way of describing preferences

1
Single Good Utility
Is more always better?
Utility Functions

 Utility
• an indicator of person’s overall well-being
• a numeric measure of a person’s happiness
• a way of describing preferences

1
Utility Functions

 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. U(2,3) = 6 > U(4,1) = U(2,2) = 4.
 Can call these numbers utility levels.
 If we let U(x1,x2) = x1x2 , this function can be a
utility function !
 Given some preferences, can we always find
the corresponding utility function?

2
Utility Functions

 Existence: Suppose preferences are complete,


reflexive, transitive, strongly monotonic and
continuous. Then there exists a continuous utility
Function which represents those
preferences
• Continuity means that small changes to a consumption
bundle cause only small changes to the preference level.

3
Utility Functions

 Consider the bundles (4,1), (2,3) and (2,2).


 Suppose (2,3)
 ((4,1)  (2,2).
 U(x1,x2) = x1x2 , is a utility function
 Consider V(x1,x2) = U2 = (x1x2) 2
 V(2,3) = 36 > V(4,1) = V(2,2) = 16.
 If we let V(x1,x2) = (x1x2) 2 , this function also
can be a utility function !

4
Utility Functions

 (Positive) Monotonic transformation


• Given a function u, f(u) is monotonic transformation of u
if u1>u2, then f(u1)>f(u2)

 (Positive) Monotonic transformation of a utility


function is also a utility function that represents the
same preferences as the original utility function

 Unique up to (positive) monotonic transformation

5
Utility Functions

 Ordinal utility: the magnitude of the utility function


is only important insofar as it orders(ranks) the
different bundles; the size of the utility difference
between two bundles does not matter
 Cardinal utility: the size of the utility difference
between two bundles is supposed to have some
sort of significance
 For examining consumers’ choice behavior, the
ordinality is sufficient in analyzing utility functions

6
Utility Functions & Indiff. Curves
 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. U(2,3) = 6 > U(4,1) = U(2,2) = 4.
 Can call these numbers utility levels.
 Note that all bundles in an indifference curve
have the same utility level.

7
Utility Functions & Indiff. Curves

(2,3) (2,2) ~ (4,1)


8
Utility Functions & Indiff. Curves
• Comparing more bundles will create a larger
collection of all indifference curves

9
Utility Functions & Indiff. Curves

• Another way to visualize this same information is


to plot the utility level on a vertical axis.

U(2,3) = 6

U(2,2) = 4
U(4,1) = 4

10
Utility Functions & Indiff. Curves

11
Utility Functions & Indiff. Curves

 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.

12
Utility Functions & Indiff. Curves

13
Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Utility Functions & Indiff. Curves

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Indifference Curves from Utility Functions

 U(x1,x2) = x1x2
 Note that U(2,3) = 6 > U(4,1) = U(2,2) = 4
 To find a corresponding I.C.,
let U(x1,x2) = x1x2 =k , that is, x2 =k/x1

29

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