Microeconomics I. Antonio Zabalza.

University of Valencia 1

Micro I. Lesson 4. Utility

In the previous lesson we have developed a method

to rank consistently all bundles in the (x,y) space and
we have introduced a concept –the indifference
curve- to help us in this analysis. Now we introduce
a related concept to rank bundles –the utility
function- that will be useful to solve the equilibrium
of the consumer in terms of calculus.

4.1 Ordinal versus cardinal utility

In the past, utility was conceived as a quantitative

measure of a person’s welfare out of consuming
goods. Now it is recognised that utility cannot be
quantified because of the impossibility of
interpersonal comparisons. So we do now as we did
in Lesson 3, we only rank bundles.

Utility function: A way of assigning a number to

every possible consumption bundle such that more-
preferred bundles get assigned larger numbers than
less-preferred bundles.

( x′ , y′) f ( x ′′, y′′) if and only if U ( x′, y ′) f U ( x′′, y ′′)

The only property about the numbers the utility

function generates which is important is how it
orders the bundles; how it ranks them. The size of
the difference between the numbers assigned to each
Microeconomics I. Antonio Zabalza. University of Valencia 2

bundle does not matter. Thus we talk about ordinal

utility.

Since only the ranking matters, there can be no

unique way to assign utility to bundles. If U(x,y)
represents one way of ranking goods, 2U(x,y) is
equally acceptable: it ranks bundles in the same
manner. Multiplying by 2 is an example of a
monotonic transformation.

Example:
U=xy
Bundle
x y U=xy

A 1 4 4
B 2 3 6
C 1 2 2

Ranking: B>A>C

U=2xy
Bundle
x y U=2xy

A 1 4 8
B 2 3 12
C 1 2 4

Ranking: B>A>C
Microeconomics I. Antonio Zabalza. University of Valencia 3

A monotonic transformation is a way of

transforming one set of numbers into another set of
numbers in a way that the order of the numbers is
preserved.

If the original utility function is U(x,y), we represent

a monotonic transformation by f [U (x , y ) ]. The
property the function f[.] has to have is that

If U1 > U 2 ⇒ f (U1 ) > f (U )

Examples of monotonic transformations:
f(U) = 2U
f(U) = 3U
f(U) = U+2
f(U) = U+10
f(U) = 5+3U
f(U) = U 3 (What about f(U) = U2?)

See that to preserve the order, f(U) must be a strictly

increasing function of U.

Utility functions have indifference curves too; they

are the level curves in the space (x,y) of the three
dimensional function U=f(x,y). The indifference
curves of a monotonic transformation of a utility
function are the same as the indifference curves of
the original utility function, only that the numbers
attached to each indifference curve are different.
Microeconomics I. Antonio Zabalza. University of Valencia 4

4.2 From utility functions to indifference curves

If you are given a utility function U(x,y), it is easy to

derive a given indifference curve from it: simply
plot all points (x,y) such that U(x,y) equals a
constant.

Examples: U(x,y)=xy
k=xy
y=k/x

y
Rectangular hyperbola

k=3

k=2

k=1

U (x , y) = x 2 y 2
Notice that since xy cannot be negative (we are in
the positive quadrant), x 2 y 2 = ( xy )2 preserves the
same order. So this utility function is a monotonic
transformation of the previous function. The formula
for the indifference curve is:
Microeconomics I. Antonio Zabalza. University of Valencia 5

φ = x2 y2
φ 1 2 = xy
y = φ1 2 / x

This is the same indifference curve map as before,

only that the levels of the indifference curves are the
squared of the previous levels

y
Rectangular hyperbola

φ=9

φ=4

φ=1

Perfect substitutes (blue pencils, red pencils)

U (x , y) = x + y
k =x +y
y=k −x

Slope -1
Microeconomics I. Antonio Zabalza. University of Valencia 6

Perfect substitutes but at differents proportions: for

example, suppose for the consumer x is twice as
valuable as y.
U (x , y ) = 2 x + y
k = 2x + y
y = k − 2x

Slope -2

In general,
U ( x , y ) = ax + by
k = ax + by
k a
y=
− x
b b
This is a utility function in which the consumer
values x as much as a/b units of y.
Microeconomics I. Antonio Zabalza. University of Valencia 7

Perfect complements (left shoe, right shoe)

U ( x , y ) = min {x , y}

If I have 2x (two right shoes) and 1y (one left shoe)

it is like if I had only one pair of shoes: I get the
same utility as with 1x and 1y.

Slope 1

1 2

The proportion need not be 1 to 1. Say, a consumer

uses always 1x (cup of cofee) with 2y (two sugars),
then
 1 
u ( x, y ) = min  x, y 
 2 

Slope 2
 Microeconomics I. Antonio Zabalza. University of Valencia 8

In general
U ( x , y ) = min {ax, by}
The slope of the axis is then a/b. Check you
understand the function min {} ⋅ .

Cobb-Douglas utility function

U (x , y ) = x a y b ; a > 0; and b > 0

This is a well known function which generates well

behaved indifference curves (smooth, negative and
convex).

y
y
a>b a<b

Good x is relatively preferred to good y x Good y is relatively preferred to good x x

Cobb-Douglas functions are frequently used in

production theory, where instead of utility we talk of
output, and instead of goods we talk of inputs.
Microeconomics I. Antonio Zabalza. University of Valencia 9

4.3 Marginal Utility and the MRS

Consider a consumer that consumes the bundle (x,y).

How does this consumer’s utility change when we
maintain the amount of y and give him a little more
of x? The change in utility per unit of change in x is
the marginal utility of x ( MU x ) .
∆U U ( x + ∆x, y ) − U (x , y )
MU x = =
∆x ∆x
MU x measures by how much utility changes when
we change x by a small amount holding y constant.
In the limit, if the change in x is infinitesimal,
δU
MU x =
δx
From the definition of marginal utility it follows that
the change in utility that results from a small
increase in x, holding y constant is:
∆U = MU x ⋅ ∆x
We have the same sort of definitions for good y;
marginal utility of y ( MU y ) .

∆U U ( x , y + ∆y ) − U (x , y )
MU y = =
∆y ∆y
δU
MU y =
δy
∆U = MU y ⋅ ∆y
Microeconomics I. Antonio Zabalza. University of Valencia 10

The utility function can be used to measure the MRS

defined in the previous lesson.
Suppose that, for a given utility function, both x and
y change. In general, when we change the quantities
consumed of x and y, the level of utility will change.
The total change in utility will be the sum of the
change in utility generated by the change in x plus
the change in utility generated by the change in y.

∆ U = MU x ⋅ ∆x + MU y ⋅ ∆y

Suppose additionally that this change in x and y is a

movement along a given indifference curve. This
means that after the movement, the level of utility
must be the same, and that ∆ U = 0 . Therefore,

0 = MU x ⋅ ∆x + MU y ⋅ ∆y

Or
∆y MU x
=−
∆x MU y
But ∆ y ∆x , measured along a given indifference
curve, is (minus) the MRS. Therefore,

∆y MU x
MRS = − =
∆x MU y

The MRS can be measured by the ratio of the

respective marginal utilities of the two goods.
Microeconomics I. Antonio Zabalza. University of Valencia 11

Annex (Some calculus)

U = U (x , y ) (1)
δ U δ U (x , y )
MU x = =
δx δx
δ U δ U (x , y )
MU y = =
δy δy
Totally differentiating (1) we find

δU δU
dU = dx + dy
δx δy
dU = MU x dx + MU y dy

Along an indifference curve dU = 0 . Therefore,

0 = MU x dx + MU y dy
dy MU x
=−
dx MU y
dy MU x
MRS = − =
dx MU y