# EXAM 2 - Chapter 4 Utility Utility a way to describe...

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Chapter 4: Utility Utility - a way to describe consumer preferences. Utility function - assigning numbers to consumers’ bundles such that more preferred = higher number. Ordinal utility - the ranking of consumer bundles. Monotonic transformation - transforms one set of numbers into another set of numbers while preserving the order (ex: multiplying all numbers by 2). Rate of change of F(u) as u changes: f/ u= (f(u2)-(f(u1))/(u2-u1). Monotonic function: always has a positive rate of change (positive slope), i.e. an increasing function, f(u2)-f(u1) always has same sign as u2-u1. If f(u) us a monotonic transformation of a utility function that represents some preference, then f(u(x1,x2)) represents the same preference. Utility function - way of assigning numbers to the different indifference curves so that higher curves get larger numbers. Cardinal utility - size of the utility difference between two bundles has significance. Level set: set of all (x1, x2) such that u(x1,x2) is a constant. Utility function: is constant along indifference curves and assign a higher label to more preferred bundles. Perfect substitutes u(x1,x2) = ax1 + bx2 (a and b are positive numbers that measure values of goods 1 and 2 to customer, slope = -a/b). Perfect complements (left and right shoes) u(x1,x2) = min{x1,x2} in proportions other than one to one – (example: 2:1 – min{x1, ½ x2}, multiply out fraction, min{2x1, x2}, basically u(x1,x2)= min{ax1, bx2}. Quasi-linear preferences

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• Spring '10
• staff
• Utility, optimal choice, Cobb Douglas

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