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Unformatted text preview: Chapter Four Utility Preferences  A Reminder x y: x is preferred strictly to y. x y: x and y are equally preferred. x y: x is preferred at least as much as is y. p ~ f Preferences  A Reminder Completeness : For any two bundles x and y it is always possible to state either that x y or that y x. ~ f ~ f Preferences  A Reminder Reflexivity : Any bundle x is always at least as preferred as itself; i.e. x x. ~ f Preferences  A Reminder Transitivity : If x is at least as preferred as y, and y is at least as preferred as z, then x is at least as preferred as z; i.e. x y and y z x z. ~ f ~ f ~ f Utility Functions A preference relation that is complete, reflexive, transitive and continuous can be represented by a continuous utility function . Continuity means that small changes to a consumption bundle cause only small changes to the preference level. Utility Functions A utility function U(x) represents a preference relation if and only if: x x U(x) > U(x) x x U(x) < U(x) x x U(x) = U(x). ~ f p p Utility Functions Utility is an ordinal (i.e. ordering) concept. E.g . if U(x) = 6 and U(y) = 2 then bundle x is strictly preferred to bundle y. But x is not preferred three times as much as is y. Utility Functions & Indiff. Curves Consider the bundles (4,1), (2,3) and (2,2). Suppose (2,3) (4,1) (2,2). Assign to these bundles any numbers that preserve the preference ordering; e.g. U(2,3) = 6 > U(4,1) = U(2,2) = 4. Call these numbers utility levels . p Utility Functions & Indiff. Curves An indifference curve contains equally preferred bundles. Equal preference same utility level. Therefore, all bundles in an indifference curve have the same utility level. Utility Functions & Indiff. Curves So the bundles (4,1) and (2,2) are in the indiff. curve with utility level U 4 But the bundle (2,3) is in the indiff. curve with utility level U 6. On an indifference curve diagram, this preference information looks as follows: Utility Functions & Indiff. Curves U 6 U 4 (2,3) (2,2) (4,1) x 1 x 2 p Utility Functions & Indiff. Curves Another way to visualize this same information is to plot the utility level on a vertical axis. U(2,3) = 6 U(2,2) = 4 U(4,1) = 4 Utility Functions & Indiff. Curves 3D plot of consumption & utility levels for 3 bundles x 1 x 2 Utility Utility Functions & Indiff. Curves This 3D visualization of preferences can be made more informative by adding into it the two indifference curves. Utility Functions & Indiff. Curves U 4 U 6 Higher indifference curves contain more preferred bundles....
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 Fall '08
 Hansen
 Microeconomics, Utility

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