Otis eek 4

9 September 2021

Utility
an indicator of a person 's overall well being Utility is seen to describe preference
only way as a
-

Utility function , a
way of assigning
a number to
every possible consumption bundle such that more preferred -
bundles get
assign larger numbers than less preferred bundles
-

> a bundle 1×1 ,

✗ 2) is preferred to a bundle Lyn , Yz) if and only if the utility of ( ✗ i. ✗ a) is larger than the utility of ly, Yz) ,

( ✗ i. ✗ a) > ( Ya Y , , ) it and only if ulxn ,

✗ a) > ulyn Yz) .

Ordinal utility the magnitude of ,

the
utility function is only important insofar as it ranks the different consumption
bundles : the site of the utility difference between
any two consumption bundles doesn't matter

Monotonic transformation ,
a
way of transforming one set of numbers into another set of numbers in a
way that

preserves the order of the numbers

> flu ) =3 u , adding any number ( e. g. flu ) = Ut 17 ) , raising u to an odd power (e. g. flu) = u
'
) , and so on

> the rate of change of flu)

f flu 2) -

fl Un )
=

U Uz -
Un

flail flail always has

-
the same sign as uz -
un

> monotonic function always have a positive slope > always increasing

=
""

tf flu) is any monotonic transformation of a

utility function that represents some particular preferences ,
then flulxn ,
✗a ) ) is also

a
utility function that represents those same preferences
1. To that ulx, a) represents particular preferences Ulxn Xz ) > Uly , y , ) if and
only if ( i. ✗ a) Y LY, Yz )
that
say ,
✗ some means , ,
✗
,

2. But if flat is monotonic ly, %) if [Link] ) ) > flu ( Ya Ya) )

a
transformation ,
then ulxn , ✗ e) > u ,
and only if ,

3.
Therefore , flu 1×1 ,
✗ ill >
flu Lyn Yz ) if and only if
, 1×1 ,
✗ a) > ( Y , yz )
, ,
so the function flu) represents the preferences in the same

the original utility function ulxr , ✗ a)

way as

Monotonic transformation of a
utility function is a utility function that represents the same preferences as the
original utility
function .

• Cardinal utility
Theories of utility that attach a
significance to the
magnitude of utility the size of the
, utility difference between two bundles

of goods is
supposed to have some sort of significance
E-xp I like one bundle twice as much if I to twice I like bundle twice
. as another am
willing pay as much for it or one

as much as another if I am
willing to run twice as far to get it or to wait twice as
long or to gamble for it at

twice the odds

 Otis eek 4
9 September 2021

•
Constructing a
utility function
Not all kind of preferences can be represented by a
utility function intransitive preferences
, so that A > Btc > A is

impossible to construct a
utility function since A is ambiguous
Utility function is a
way to label the indifference curves such that higher indifference curves get larger numbers

> how to draw it

line
Draw the
diagonal illustrated and label each indifference curve with its distance from the
origin measured along
-

the line

> if preferences are monotonic then the line through the

origin must intersect every indifference curve exactly once

✗2
" " "" distance
"
from origin
" "
" Nearly any kind of reasonable preferences can
"
" be
represented by a
utility function
" "
"'t indifference
""o curves

in

• Some examples of utility functions

Level set the set of all ( X Xz ) Such
, , ,
that ulxn , ✗ , ) equals a constant, for each different value of the constant you get ,
a

different indifference curve

> Exp The utility function is Ukr , ✗ 2)

.

given by : = ✗
a ✗2

typical indifference curve is

just the set of all ×, and Xz ,
K = ✗ nxz for some constant K

K
Xz =
for K = 1,2 , 3 , - . -

✗
,

✗2

1<=1

1<=2

1<=1
×,

> Exp .
Utility function vlxn , ✗ a) = ✗ i ✗i

( X, ✗ a)
' 2
v14 , Xz ) =
Xi Xi = = Vlxn , ✗ a)

Utility function V14 ,

✗ a) is just the Square of the utility function ulxn ,
✗ a)
* Since ulxn ,
✗ a) Cannot be negative , v14.x ) , is a monotonic transformation of the previous utility function ulxn , ✗ 2)
the utility function v(✗ i. ✗ a) Xi Xi has to have the same
* =
exactly shaped indifference curves as those depicted for
U (Xp , Xz ) = ✗, ✗z

Perfect substitutes , all that mattered to the consumer was the total of goods ,
it is natural to measure utility by the total number of

goods

> for one to one case ,

the
utility function > UH, , ✗a) = ×, + ✗a

> for other than one to one case , the consumer would require two units of good 2 to compensate him for unit of
giving up one

good 1 ,
this means that good 1 is twice as valuable to the consumer as
good 2

the Ulxi Xz ) + ✗2
*
utility function ,
=
2×1

* the utility yields indifference curves with a slope of -2

The formula can be represented as UIX , , ✗ a) = a ✗ it biz > linear function as ✗z =

Ib G- ✗
-

n
,
a s b are some positive
"
Positive numbers that measure the "
value of goods 1 and 2 to the consumer

* the indifference curve slope is given by -

%
 Otis eek 4
9 September 2021

Perfect complements ,
the consumer
only cares about the number of pairs of goods they has , to choose the number of pairs
of goods the function
as
utility
> the number of
complete pairs of goods that
you have is the minimum of the number of good 1 you have (4) ,
and

the number of good 2

you have ( Xz )

> the
utility function UH, , ✗ a) = min { ✗i. ✗ } a

Exp if.
we have a bundle of good such as 110 , 10 ) and we add one more unit of good 1 so that we
get 111,101 this
,
will

leave us on the same indifference curve since min { 10,70 } = min { 11,10} = 10

So 41×1 ,
✗ 2) =
min { Xi , Xi } is a possible utility function to describe perfect complements
the number teaspoons of sugar
> if Xi is the number of cups of tea available S X, is of available then the utility function
'
will be Ula , ×, ) = min { ✗ i. -2×2 } since 1 Cup of tea requires 2 teaspoons of sugar
• we could
get rid of the fraction by multiply it by 2 ,
so the
utility function Ulxn will be , ✗ c) = min {2×11×1}
> the formula of perfect
complement utility function is given by ulxn ✗ 2) min { axiibxz } where Sb
-

positive
=
, a are

numbers that indicates the proportions in which the goods are consumed

Quasi linear preferences , all of the indifference curves are just vertically
"
shifted
"
versions of indifference curve

> the equation for the indifference curve is Xz = K -

✓ ×, ( ) where K is a different constant for each indifference curve

> the
height of each indifferent curve is some function of ✗
1, -
v14 ) + K

•
higher the value of K give higher indifference curves (the minus sign is only a convention )

✗2

Utility function : ulx, ,

✗ 2) = K = v14) 1- ✗ 2 > linear in good 2

but possibly nonlinear in good 1

Quasi linear utility partly ,

linear utility
indifference > Ula , ✗ a) = IF 1- ✗ z
Curves
> UH, , ✗ a) = In ✗ it ✗ 2
Xp
> not particularly realistic

Cobb i ✗ it s d positive that describe the preferences of

Douglas preferences utility function of ulxn ✗ 2) = ✗ where c are the
-

,
,

consumer

A B
✗z
✗2

✗i
Xp
c- .
Yz D= 42 ( = Ys D= Ys
Cobb -

Douglas indifference curves look

just like the nice convex monotonic indifference curves that we referred to as well - behaved

indifference curves

> Cobb -

Douglas preferences are the standard example of indifference curves that look well-behaved and the formula describing them

is about the simplest algebric expression that generates well-behaved preferences

> oluite useful to present

algebric examples of the economic ideas

> a monotonic transformation of the Cobb -

Douglas utility function will represent exactly the same preferences

am the natural
log of utility v (×, ,
✗ 2) = In lxi ✗ 9) = clnx, tdlnxz
C d
am
Exp .
Cobb Douglas form
-
v14 ,
✗ 2) = ✗ i ✗ it , raising utility to the Power -
> ✗
,
' +d
Xzctd
number ¥ utility function (× , a) it i a
-

define a new a =
now write the v ,
✗ = ✗ ✗
,

we can always take a monotonic transformation of the Cobb -

Douglas utility function that make the exponents sum to I

 Otis eek 4
9 September 2021

•
Marginal utility
Marginal utility is the rate of change with
respect to good 1

U u ( ✗n t ✗a.✗ 2) -
U (✗n ,
✗ 2)
MU , = =

✗, ✗n

measures the rate of

change in
utility ( v ) associated with a small change in the amount of good 1 I ×, ) the
,
amount

of good 2 is held fixed in this calculation

to calculate the change in utility associated with

> a small
change in consumption of good 1

du
U = MY ×
, > Mu
,
=

2×1

marginal utility with respect to good 2

U u (× , ,
✗z t Xz ) - U IX, ,
✗ 2)
MU 2 = =

✗ ✗2
z

When we compute the marginal utility with the respect to good 2 , we

keep the amount of
good 1 constant

> ( acuate the

change in utility associated with a change in the consumption of good 2

U = M V2 ✗
2

the
magnitude of marginal utility depends on the magnitude of utility it depends
,
on the particular way that we

choose to measure
utility
•
if we multiplied utility by 2 , marginal utility would also be multiplied by 2 > represent the same preferences but

scaled differently
has behavioral
> marginal utility no content

Choice behavior only reveals information different bundles of goods

aea
about the consumer
way a ranks

aea
Marginal utility depends on the particular utility function that we use to reflect the preference ordering and its

magnitude has no particular significance

•
marginal utility can be used to calculate something that does have behavioral content

•
Marginal utility and MRS

A change in the consumption of each good I ×, ,

✗ a) that keeps utility constant ( a change in consumption that moves us

a
long the indifference curve
MU , ✗n t Mlk Xz =
U = 0

total differential 1st order where Muz ×, = -

Mun Xi > Xz MY
= -

✗,
Mvz

Slope of the indifference curve

✗2 MUI
MRS = = -

✗, MU 2

The good the level

algebric sign of the MRS is
negative if you get you have get less of
to
. more of good 1 2 in order to keep same

of utility
> often refers to the MRS by its absolute value (as a positive number )
> the MRS can be measured by observing a
person's actual behavior

if multiply
we
utility by >
marginal utility multiplied by
an
2 is 2

2 MU, The MRS remains the same , the graphic shape

MRS = -

2 Muz stays but the label

changes
 Otis eek 4
9 September 2021

•
Utility for commuting
if a bundle of goods ✗ is chosen when a bundle of goods Y is available then ✗ must have a
higher utility than Y
consumers describe their behavior
>
by examining choices make we can estimate a
utility function to

•
Applied in the field of transportation economics to study commuter's behavior

Exp If (×,
.

, Xz ,
. . .
.
Xn ) represents the values of n different characteristics of driving and (Yn Yz , ,
. . .
. Yn ) represents the

values the bus

of taking
U ( Xi Xi , ,
. . .
, Xn ) =
By ✗ n t Bz Xzt . . .
+ Bn ✗ n

the coeficients Bi , Bz ,
and so on are unknown parameters

> monotonic transformation of this utility function would describe the choice behavior equally well

[Link] c) ,
=
-0.147 TW -

0.0411 TT -
2.24C

TW =
total walking time to and from bus or car

TT = total time of trip in minutes

C total cost
=
of trip in dollars

The Coefisients describe the that an

average household places on the various characteristics of their commuting
weight
trips ; the marginal utility of each characteristic

the ratio of coeficient to another substitution between characteristic and

> one measures the
marginal rate of one

another

• the ratio of cost to travel time indicates the average consumer 's tradeoff between these two variables

an estimated utility function can be very valuable for determining whether or not it is worthwhile to make some
change in

the public transportation system

> significant factors explaining mode choice is the time involved in

taking the trip
on this number gives us a measure of the dollar benefit of providing more timely bus service

this benefit must be to the cost providing determine if

•
compared of more
timely bus service in order to such provision
is worthwhile