Utility Function Properties
Given a set of preferences is there an unique
utility function? No, 2u(x) exhibits the same
preferences as u(x). In fact, any monotonic
transformation will exhibit the same
preferences.
Is Utility Cardinal or Ordinal?
Cardinal?
Ordinal?
Ordinal!
Monotonicity
Consider two bundles x and y. Then x{y if
xiyi for all i=1,...,n and
xi>yi for some i=1,...,n.
Rules out “thick” indifference sets.
Example
Suppose u(x1,x2) = x1 + x2 and let f(y) = y3.
v(x1,x2) = f(u(x1,x2)) = (x1 + x2)3 yields the same
preferences.
Note that f(y) is a monotonically increasing
function.
Two more axioms
Monotonicity
Convexity
Convexity
Suppose x and y are two bundles with x~y.
Let z = tx + (1-t)y for t(0,1), then if
preferences are convex z{x and z{y. The
implication is that consumers prefer the
weighted average of two indifferent bundles to
both of the bundles.
 Indifference Curves

The six axioms result in “nicely-shaped”

indifference sets we will call indifference
curves. Generally we will assume that
consumers consume only two goods.
The following slides show:
A typical indifference curve
A set of indifference curves

Marginal Rate of Substituion

The Marginal Rate of Substitution is the

negative of the slope of an indifference curve.
The equation for an indifference curve is
u(x,y) = k,
where k is a constant and x and y are the two
goods.

u(x,y) = k is our indifference curve equation. Interpretation

Totally differentiate this equation:
(0u/0x)dx + (0u/0y)dy = 0
Rearrange to get dy/dx is the slope of the indifference curve
through the point (x,y)
dy/dx = - (0u/0x)/(0u/0y)
0u/0x is the marginal utility of good x
Thus the MRS is
0u/0y is the marginal utility of good y
MRS = -dy/dx = (0u/0x)/(0u/0y)
So the Marginal Rate of Substitution (MRS) is
equal to the ratio of the marginal utilities.
What units are attached to the MRS?
 Intuition
The MRS represents how many units of good
y a consumer has to give up to get one more
unit of good x holding utility constant.
Alternative Method of Determining
the MRS
Consider u(x,y) = k. We can rewrite this as
y = g(x). Differentiate with respect to x to get
dy/dx = g1(x). Thus, we can calculate the MRS
as g1(x).
Another Example
u(x,y) = xayb Cobb-Douglas utility
xayb = k becomes y = k1/bx-a/b
Differentiate to get dy/dx = (-a/b)k1/bx-(a/b)-1
This looks like a mess but plug in k = xayb
This yields dy/dx = (-a/b)xa/byb/b x-(a/b)-1
= (- a/b)y/x
Examples of Utility Functions
3 u(x,y) = xayb, where a,b > 0
3 u(x,y) = ax + by, where a,b > 0
3 u(x,y) = min{ax,by}, where a,b > 0
3 u(x,y) = x + g(y), where g(y) is a concave
function
3 Exercise find MRS for each of the above
utility functions
Example
u(x,y) = ax +by
Equation for indifference curve:
ax +by = k OR y = k/b -(a/b)x
dy/dx = -(a/b) which yields the same MRS.
This was easy do a harder one!
Conclusion
Utility function: u(x,y)
Equation for indifference curve y = g(x)
MRS = -g1(x) = - (0u/0x)/(0u/0y)