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...