Chapter4 - Chapter 4 Utility 1 Two ways of viewing...

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Chapter 4 - Utility 1. Two ways of viewing utility (a) old way - measures how “satisfied” you are not operational many other problems (b) new way summarizes preferences a utility function assigns a number to each bundle of goods so that more preferred bundles get higher numbers that is, u ( x 1 , x 2 ) > u ( y 1 , y 2 ) if and only if ( x 1 , x 2 ) ( y 1 , y 2 ) only the ordering of bundles counts, so this is a theory of ordinal utility advantages operational gives a complete theory of demand 2. Utility functions are not unique (a) if u ( x 1 , x 2 ) is a utility function that represents some preferences, and f () is any increasing function, then f ( u ( x 1 , x 2 )) represents the same preferences (b) why? Because u ( x 1 , x 2 ) > u ( y 1 , y 2 ) only if f ( u ( x 1 , x 2 )) > f ( u ( y 1 , y 2 )) (c) so if u ( x 1 , x 2 ) is a utility function then any positive monotonic transformation of it is also a utility function that represents the same preferences 3. Constructing a utility function (a) can do it mechanically using the indifference curves (see figure 4.2.
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