Lecture_02b_Utility

Lecture_02b_Utility - Lecture 2b: Utility Outline: 1....

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Lecture 2b: Utility c 2008 Je/rey A. Miron Outline: 1. Introduction 3. Monotonic Transformations 4. Cardinal Utility 5. Constructing a Utility Function 6. Examples of Utility Functions 7. Preview: Marginal Utility and the MRS 1 Introduction Let±s summarize what we have done so far. We have described the constraints that a consumer faces, i.e., discussed the budget constraint. In many cases, this constraint is simple, whether when seen as an equation or as a graph. But in others, it gets messier. We have also discussed a way of modeling what the consumer wants. We referred to this as preferences, and while we have only described them graphically, they can also be described algebraically, sometimes in a simple way, as we will see. So far we have said nothing about what the consumer is going to choose; that is, we have not modeled the problem the consumer faces, although it has obviously been implied, and you may have seen it in other classes. We won±t do that for another lecture or so. 1
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desires / preferences. This approach is known as the utility function approach; we are going to think about each possible consumption bundle as giving the consumer some amount of ll de³ne it more explicitly shortly. The early versions of consumer theory focused on utility, without any mention of preferences, and assumed we could assign a unique utility number to every choice or bundle. These utility numbers had some sort of independent meaning. In particular, we could add and subtract them across people. Modern economic theory does not proceed in this way. It focuses instead on preferences, and simply assumes that given various bundles, consumers can rank them and make choices. Utility turns out to be, usually, a convenient way to summarize these preferences, but it is the preferences that are fundamental. The reason we are going to move to utility functions from preferences is that they are easier to work with. But it is useful to understand that they are less fundamental than preferences per se. In particular, the utility numbers have no cardinal meaning; they simply indicate that, if one bundle has higher utility number than another, then the one is preferred to the other. The actual value of the utility numbers is irrelevant, sort of like rankings at a golf tournament. Note also that economists use both the preference approach and the utility func- tion approach. We want to understand the relation between them. For many purposes, the two approaches are equivalent. Also, in many settings, it is not obvi- ous why ones needs to have bothered with the preference approach. In a few crucial cases, however, it matters a lot, and that is why we need to do both.
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This note was uploaded on 09/16/2009 for the course ECONOMICS 1010A taught by Professor Jeffreya.miron during the Fall '09 term at Harvard.

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Lecture_02b_Utility - Lecture 2b: Utility Outline: 1....

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