Structural Properties of Utility Function:

Outline:
• Desirability: Monotonicity, Non-satiation
• Convexity, Concavity, Quasi-concavity
• Common Utility Functions and preferences

1
 From
From Last
Last Class
Class
Definition
The utility function u : X ! R represents the binary relation % on X if
x % y , u(x) ≥ u(y ).

Theorem (Debreu)
Suppose X ⊆ Rn . A binary relation % on X is complete, transitive, and continuous
if and only if it admits a continuous utility representation u : X ! R.

Today we study connections between a utility function and the underlying

preference relation it represents.

Structural Properties of Utility Functions

The main idea is to understand the connection between properties of
preferences and characteristics of the utility function that represents them.

NOTATION:
From now on, assume X = R n .
If xi ≥ yi for each i, we write x ≥ y . 2
 Monotonicity
Monotonicity says more is better.

Definitions
A preference relation % is weakly monotone if x ≥ y implies x % y .
A preference relation % is strictly monotone if x ≥ y and x 6= y imply x ≻ y .

In our notation, x ≥ y and x 6= y imply xi > yi for some i.

Question
What does monotonicity imply for the utility function representing %?

More precise intuition:

• Weak monotonicity: more does not harm
• Increasing the amount of some commodities does not harm
• Strict monotonicity: more is better
• Increasing even a single commodity is better
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 Monotonicity: An Example
Monotonicity: An Example

Example
Suppose % is the preference relation on R2 defined by
x %y if and only if x1 ≥ y1
% is weakly monotone, because if x ≥ y , then x1 ≥ y1 .
It is not strictly monotone, because
(1, 1) ≥ (1, 0) and (1, 1) 6= (1, 0)
but
not [(1, 1) ≻ (1, 0)]
since (1, 0) % (1, 1).

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 Strict
StrictMonotonicity:
Monotonicity: An
An Example
Example

The lexicographic preference on R2 is strictly monotone

Proof: Suppose x ≥ y and x 6= y .
Then there are two possibilities:
(a) : x1 > y1 and x2 ≥ y2 or (b) : x1 ≥ y1 and x2 > y2 .
If (a) holds, then
x % y because x1 ≥ y1 , and
not (y % x ) because neither y1 > x1 (excluded by x1 > y1 ) nor y1 = x1 (also
excluded by x1 > y1 ).
If (b) holds, then
x % y because either x1 > y1 or x1 = y1 and x2 ≥ y2 , and
not (y % x ) because not (y1 > x1 ) (excluded by x1 ≥ y1 ) and not (y2 ≥ x2 )
(excluded by x2 > y2 ).
In both cases, x % y and not (y % x) thus x ≻ y .

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 Monotonicity
Monotonicity and
and Utility
Utility Functions
Functions
Definitions
A function f : Rn ! R is
nondecreasing if x ≥ y implies f (x) ≥ f (y );
strictly increasing if x ≥ y and x 6= y imply f (x) > f (y ).

Monotonicity is equivalent to the corresponding utility function being

nondecreasing or increasing.

Proposition
If u represents %, then:
1 % is weakly monotone if and only if u is nondecreasing;
2 % is strictly monotone if and only if u is strictly increasing.

Proof: Part of HW4

Proof.
Question 1a. Problem Set 3, due next Monday.
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 Monotonicity and Utility Functions
Example: u(x1 , x2 ) = min{x1 , x2 }

• Weakly monotone, since

min{x1 + α, x2 + δ} ≥ min{x1 , x2 } for all α,δ ≥ 0
• Not strictly monotone, since
min{x1 + α, x2 } > min{x1 , x2 } does not hold for α > 0 if
min{x1 , x2 } = x2
Example: u(x1 , x2 ) = x1 + x2

• Weakly monotone, since

(x1 + α) + (x2 + δ) ≥ x1 + x2 for all α,δ ≥ 0

• Strictly monotone, since

(x1 + α) + x2 ≥ x1 + x2 for all α > 0 7
 Local Non-Satiation
Local (LNS)
Non Satiation
Definition
A preference relation % is locally nonsatiated if for all x 2 X and " > 0, there exists
some y such that ky − xk < " and y ≻ x.

For any consumption bundle, there is always a nearby bundle that is strictly
preferred to it.

Definition
A utility function u : X ! R is locally nonsatiated if it represents a locally
nonsatiated preference relation %; that is, if for every x 2 X and " > 0, there exists
some y such that ky − xk < " and u(y ) > u(x).

Example: The lexicographic preference on R2 is locally nonsatiated

Fix (x1 , x2 ) and " > 0.
Then (x1 + "2 , x2 ) satisfies k(x1 + "2 , x2 ) − (x1 .x2 )k < "
and (x1 + "2 , x2 ) ≻ (x1 , x2 ).
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 Local Non Satiation and Strict Monotonicity
Local Non-Satiation and Strict Monotonicity
Proposition
If % is strictly monotone, then it is locally nonsatiated.

Proof.
Let x be given, and let y = x + n" e, where e = (1, ..., 1).
Then we have yi > xi for each i.
Strict monotonicity implies that y ≻ x.
Note that v
u n % &
uX " 2 "
||y − x|| = t = p < ".
n n
i =1

Thus % is locally nonsatiated.

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Indifference sets
Note: strict
monotonicity implies
that indifference curves
are negatively sloped.

To keep the utility level

the same, an increase
in the amount of one
good must be
accompanied by a
decrease in the quantity
of other goods.

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oof. By Debreu’s Theorem there continuous u(x) that represents %. Almost by
exists a Preferences
Convex
finition we have Convex Preferences
Definitions C% (A) = arg max u(x)
A preference relation % is x2A
✓⇢ ◆
convex if =u 1 max u(x) .
x2A
x % y ) αx + (1 − α)y % y for all α 2 (0, 1)
en we are maximizing
strictly convex aifcontinuous function on a nonempty compact set. By the Extreme
lue Theorem, the set of maximizers is nonempty. Compactness (which, in Rn , is equiv-
x % y and x 6= y ) αx + (1 − α)y ≻ y for all α 2 (0, 1)
nt to closedness and boundedness) follows from the boundedness of A, the closedness of
e singleton set {maxx2A u(x)}, and the continuity of u.

Convexity says that taking convex combinations cannot make the decision
2 Structural properties of utility
maker worse o§.
Strict convexity says that taking convex combinations makes the decision
maker
re are some better o§.that were not really covered in lecture. Throughout this part we
definitions
Definition:
e assuming = Rn . Recall
thatAXpreference relation is convex
the (partial) if for
vector every bundle
ordering Rn , x y if
x, itsinupper
convention
Question
ycounter
i for all set
i = is
{1,convex.
2, ..., n}.
What does convexity imply for the utility function representing %?
Definition:
efinition 2.16. C ✓ X is convex if, 8 x, y 2 C and ↵ 2 [0, 1], we have ↵x + (1 ↵)y 2 C.
Geometrically, this means that any line segment whose two end points are in
C lies completely
ometrically, this means inside
that C.
any line segment whose two endpoints are in C lies com- 11
Convex Preferences

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 Strict convexity says that taking convex combinations makes the decision
Convex Preferences: An Example
maker better o§.

Question Convex Preferences: An Example

What does convexity imply for the utility function representing %?

Let % on R2 be defined as x % y if and only if x1 + x2 ≥ y1 + y2 is convex

Proof: Suppose x % y , i.e. x1 + x2 ≥ y1 + y2 , and fix α 2 (0, 1).
Then
αx + (1 − α)y = (αx1 + (1 − α)y1 , αx2 + (1 − α)y2 )
So,
[αx1 + (1 − α)y1 ] + [αx2 + (1 − α)y2 ] = α[x1 + x2 ] + (1 − α)[y1 + y2 ]
| {z }
≥y1 +y2
≥ α[y1 + y2 ] + (1 − α)[y1 + y2 ]
= y1 + y2 ,
proving αx + (1 − α)y % y .
This is not strictly convex, because (1, 0) % (0, 1) and (1, 0) 6= (0, 1) but
1 1 1 1
(1, 0) + (0, 1) = ( , ) % (0, 1).
2 2 2 2 13
 Convex Preferences: 2 Functions
The utility function u(x1,x2) = ax1 + bx2, where x1 and x2 are substitutes, and
the utility function v(x1,x2) = min{ax1, bx2}, where a, b >0, do represent
convex but not strictly convex preferences.

αx + (1− α) y ~ z

Perfect Substitutes Perfect Complements

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 Convex Preferences
What does convexity of preferences
mean?
1. Taste for diversification: an
individual with convex preferences
prefers the convex combination of x
and y rather than x or y.

2. Diminishing marginal rate of

substitution
∂x2 ∂u / ∂x1
MRS1,2 = − =
∂x1 ∂u / ∂x2
• MRS1,2 describes the amount of good 2 the consumer must be given to
compensate her for a one-unit marginal reduction in her consumption of
good 1.
• - MRS1,2 is the slope of the indifference curve
• A diminishing MRS implies that consumer needs to give up less units of
good 2 for an additional unit of good 1 as the bundle on the same
indifference curve contains more good 1.
• The equation above can be found by totally differentiating an ind. curve.
 Shapes of Functions
Shapes of Functions
Definitions
Suppose C is a convex subset of X . A function f : C ! R is:
concave if
f (αx + (1 − α)y ) ≥ αf (x) + (1 − α)f (y )
for all α 2 [0, 1] and x, y 2 C ;
strictly concave if
f (αx + (1 − α)y ) > αf (x) + (1 − α)f (y )
for all α 2 (0, 1) and x, y 2 X such that x 6= y ;
quasiconcave if
f (x) ≥ f (y ) ) f (αx + (1 − α)y ) ≥ f (y )
for all α 2 [0, 1];
strictly quasiconcave if
f (x) ≥ f (y ) and x 6= y ) f (αx + (1 − α)y ) > f (y )
for all α 2 (0, 1).

A function f is (strict) convex if the inequalities in the definition of (strict) concavity is

reversed. 16
 Quasiconcave Utility and Convex upper Contours

Quasiconcavity

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 Convexity and Quasiconcave Utility Functions
Convexity and Quasiconcave Utility Functions
Convexity is equivalent to quasi concavity of the corresponding utility function.

Proposition
If u represents %, then:
1 % is convex if and only if u is quasiconcave;
2 % is strictly convex if and only if u is strictly quasiconcave.

Convexity of % implies that any utility representation is quasiconcave, but not

necessarily concave.

Proof: Part of HW4

Proof.
Question 1b. Problem Set 3, due next Monday.

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 QuasiconcaveUtility
Quasiconcave Utility and
and Convex
Convex upper
UpperContours
Contours
Proposition
Let % be a preference relation on X represened by u : X ! R. Then, the upper
contour set is a convex subset of X if and only if u is quasiconcave.

Proof.
Suppose that u is quasiconcave.
Fix z 2 X , and take any x , y 2% (z).
Wlog, assume u(x ) ≥ u(y ), so that u(x ) ≥ u(y ) ≥ u(z), and let α 2 [0, 1].
By quasiconcavity of u,
u(z) ≤ u(y ) ≤ u(αx + (1 − α)y ),
so αx + (1 − α)y % z.
Hence αx + (1 − α)y belongs to % (z), proving it is convex.
Now suppose that % (z) is convex for all z 2 X .
Let x , y 2 X and α 2 [0, 1], and suppose u(x ) ≥ u(y ).
Then x % y and y % y , and so x and y are both in % (y ).
Since % (y ) is convex (by assumption), then αx + (1 − α)y % y .
Since u represents %,
u(αx + (1 − α)y ) ≥ u(y )
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Thus u is quasiconcave.
 Convexity
Convexity and
and Induced Choices
Induced Choices
Proposition
If % is convex, then C% (A) is convex for all convex A.
If % is strictly convex, then C% (A) has at most one element for any convex A.

Proof.
Let A be convex and x, y 2 C% (A).
By definition of C% (A), x % y .
Since A is convex: αx + (1 − α)y 2 A for any α 2 [0, 1].
Convexity of % implies αx + (1 − α)y % y .
By definition of C% , y % z for all z 2 A.
Using transitivity, αx + (1 − α)y % y % z for all z 2 A.
Hence, αx + (1 − α)y 2 C% (A) by definition of induced choice rule.
Therefore, C% (A) is convex for any convex A.
! !
Now suppose there exists a convex A for which C% (A)! ≥ 2.
!
Then there exist x , y 2 C% (A) with x 6= y .
Since x % y and x 6= y , strict convexity implies αx + (1 − α)y ≻ y for all
α 2 (0, 1).
Since A is convex, αx + (1 − α)y 2 A, but this contradicts the fact that
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y 2 C% (A).
 Quasiconcave Utility
Bundles x and y lie on the same indifference curve (IC), so u(x) = u(y).

For the strictly convex IC’s, u(.) For the linear IC’s, u(.) satisfies
satisfies strict quasiconcavity quasiconcavity but not strictly.

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 Relationship btw quasiconcavity and concavity
Concavity ⇒ Quasiconcavity
Quasiconcavity ¬⇒ concavity

If a function is concave, then for any x,y in X

( ) ( )
f αx + (1− α) y ≥ αf (x) + (1− α) f ( y) ≥ min{ f (x), f ( y)} for any α ∈ 0,1

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 Quasiconcavity
• A concave u(.) exhibits diminishing marginal utility
• That is, for an increase in the consumption bundle, the increase in
utility is smaller as we move away from the origin.
• A convex u(.) exhibits increasing marginal utility
• That is, for an increase in the consumption bundle, the increase in
utility is largeras we move away from the origin.
Concave and quasiconcave u(.) (3D) Convex but quasiconcave u(.) (3D)

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 Quasiconcavity

6 6
4 4
• Utility function v(x1 , x2 ) = x1 x2 is a strictly increasing transformation of
1 1
4 4
u(x1 , x2 ) = x1 x2

• That is, v(x1 , x2 ) = f (u(x1 , x2 )) where f(u) = u6

• Therefore, utility functions u and v represent the same preference

relation.

• Both utility functions are quasiconcave althouth one of them is concave

and the other is convex.

• Hence, we normally only require utility functions to satisfy quasiconcavity.

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 Common Utility Functions
Cobb-Douglas Utility Functions
• Two goods: x1 and x2
u(x1 , x2 ) = Ax1α x2β
where A, α, β > 0.
• Taking logs on both sides:
log u = log A + αlog x1 + βlog x2
• Hence, the exponents in the original u(.) can be interpreted as
elasticities:
∂u(x1 , x2 ) x1 x1
εu,x = . = αAx1 x2 . α β = α
α−1 β
1
∂x1 u(x1 , x2 ) Ax1 x2
• Intuitively, one-percent increase in x1 increases utility by α percent.
• Similarly, εu,x = β
2

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 Common Utility Functions
• Marginal Utilities: ∂u ∂u
>0 >0
∂x1 ∂x2
αAx1α−1 x2β αx2
• A diminishing MRS: MRS1,2 = = decreasing in x1.
βAx1 x2
α β−1
βx1
• Hence, IC’s become flatter as x1 increases.

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 Common Utility Functions
Perfect Substitutes
• Two goods: x1 and x2,
u(x1 , x2 ) = Ax1 + Bx2
where A, B > 0.
• Characterized by constant MRS, since marginal utilities are also
constant
∂u ∂u A
=A =B MRS1,2 =
∂x1 ∂x2 B

• Therefore, IC’s are straight lines.

• Consumer is willing to give up
A/B units of x2 for an additional
unit of x1.
• Examples: Coke and Pepsi,
butter and margarine, tea and
coffee 27
 Common Utility Functions
Perfect Complements
• Two goods: x1 and x2,
u(x1 , x2 ) = A⋅ min{αx1 + βx2 }
where A, α, β > 0.
• Consumer only enjoy consuming the two good together at some
combination rate. Increasing consumption of one of the good
without the other good entails no increase in utility
• The IC’s are right angle
the a kink at αx = βx
1 2
• The slope of the ray
indicates the combination
rate at which both goods
must be consumed to
attain higher utility.
• Examples: cars and gas
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Right and left side of shoes.
 Common Utility Functions
Constant Elasticity of Substitution (CES) Utility Function
• Two goods: x1 and x2, σ
⎡ σ−1 σ−1 ⎤σ−1
u(x1 , x2 ) = ⎢αx1 σ + βx2 σ ⎥
⎢⎣ ⎥⎦
where σ measure the elasticity of substitution between goods x1 and
x2.
⎛x ⎞
∂⎜ 2 ⎟
⎝ x1 ⎠ MRS1,2
σ= ⋅
∂MRS1,2 x2
x1

• The other utility functions

are special cases of CES
utility function 29
 Common Utility Functions
Quasilinear Utility Function
• Two goods: x1 and x2,
u(x1 , x2 ) = v(x1 ) + bx2
where x2 enters linearly, b > 0, and v(x1) is a non-linear function of x1.

• Examples:
• v(x1) = a lnx1
• v(x1) = ax1α, a>0 and
α ≠ 1.

• MRS is constant in the good

that enters linearly.

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 Common Utility Functions
• For u(x1 , x2 ) = v(x1 ) + bx2 , the marginal utilities are
∂u ∂v ∂u
= =b
∂x1 ∂x1 ∂x2

which implies ∂v
∂x1
MRS1,2 =
b

• Quasilinear preference are often used to represent the

consumption of goods that are relatively insensitive to income.
• Examples: garlic, toothpaste, etc.

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 Quasi-linear Utility
Quasi-linear Utility
Definition
The function u : Rn ! R is quasi-linear if there exists a function v : Rn−1 ! R
such that u(x, m) = v (x) + m.

We usually think of the n-th good as money (the numeraire).

Proposition
The preference relation % on Rn admits a quasi-linear representation if and only
1 (x, m) % (x, m0 ) if and only if m ≥ m0 , for all x 2 Rn−1 and all m, m0 2 R;
2 (x, m) % (x 0 , m0 ) if and only if (x, m + m00 ) % (x 0 , m0 + m00 ), for all x 2 Rn−1
and m, m0 , m00 2 R;
3 for all x, x 0 2 Rn−1 , there exist m, m0 2 R such that (x, m) ∼ (x 0 , m0 ).

1 Given two bundles with identical goods, the consumer always prefers the one
with more money.
2 Adding (or subtracting) the same monetary amount does not chage rankings.
3 Monetary transfers can always be used to achieve indi§erence.

Proof:
Proof. part of HW4 32

Question 1c. Problem Set 3, due next Monday.

 Quasi-linear
Quasi-linear Preferences andUtility
Preferences and Utility
Proposition
Suppose that the preference relation % on Rn admits two quasi-linear
representations: v (x) + m, and v 0 (x) + m, where v , v 0 : Rn−1 ! R. Then there
exists c 2 R such that v 0 (x) = v (x) − c for all x 2 Rn−1 .

Proof.
Let v (x) + m and v 0 (x) + m both represent %.
Given any x0 2 Rn−1 , for all x 2 Rn−1 there exists nx such that
(x, 0) ∼ (x0 , nx ). (by (2) and (3) of the previous Proposition.)
Since the utility functions both represent % we have
v (x) + 0 = v (x0 ) + nx and v 0 (x) + 0 = v 0 (x0 ) + nx
Thus nx = v 0 (x) − v 0 (x0 ). Therefore
v (x) = v (x0 ) + v 0 (x) − v 0 (x0 )
| {z }
=n x

Hence, for all x 2 Rn−1 ,

a constant c
z }| {
v (x) − v 0 (x) = v (x0 ) − v 0 (x0 ) ) v 0 (x) = v (x) − c. 33
 Homothetic Preferences and Utility
Homothetic Preferences and Utility
Homothetic preferences are also useful in many applications, in particular for
aggregation problems.

Definition
The preference relation % on X is homothetic if for all x, y 2 X ,
x ∼ y ) αx ∼ αy for each α > 0

Proposition
The continuous preference relation % on Rn is homothetic if and only if it is
represented by a utility function that is homogeneous of degree 1.

A function is homogeneous of degree r if f (αx) = αr f (x) for any x and α > 0.

Proof:
Proof. part of HW4
Question 1d. Problem Set 3, due next Monday.

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