Preference, Utility, and Choice

Lecture 1: Preference, Utility, and Choice

Advanced Microeconomics I

Yan Li

School of Economics

Central University of Finance and Economics

September 12, 2018

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Agenda

Preferences and Basic Properties

Utility Representation
Special Preferences
Revealed Preferences
Required Reading: Ch. 1-3, MWG

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

De…nition of Preferences

% is a binary relation on the set of alternatives X , allowing

the comparison of pairs of alternatives x, y 2 X .
strict preference relation
indi¤erence relation

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Rational Preferences

Rational () complete and transitive

Completeness
Transitivity
Re‡exivity (?)

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Rational Preferences

Rational Preference () Complete Preorder

Preorder () re‡exive and transitive preference

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Comparison of Concepts

Preorder VS. Partial Order

Preorder () re‡exive and transitive preference
Partial Order () re‡exive, antisymmetric and transitive
preference
Asymmetry, Symmetry, and Antisymmetry

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Monotonicity

Monotonicity: y x !y x
Strong Monotonicity: y > x ! y x
Weak Monotonicity: y x !y %x

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Nonsatiation

Nonsatiation: 8x 2 X , 9y 2 X such that y x

Local Nonsatiation: 8x 2 X , 8ε > 0, 9y 2 X such that
ky x k ε and y x

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Convexity

Convexity: y % x ^ z % x ! 8α 2 [0, 1] , αy + (1 α) z % x
Strict Convexity:
y % x ^ z % x ^ y 6= z ! 8α 2 (0, 1) , αy + (1 α) z x

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Exercises

Monotonicity =) LNS
Theorem: If f : R 2 ! R is continuous, then it is not 1-1
Strict Convexity + Nonsatiation =) LNS
Convexity + Nonsatiation ; LNS

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Continuity

Continuity: The preference relation % on X is continuous if

for any sequence of pairs f(x n , y n )gn∞=1 with x n % y n
8n 2 N, x = limn !∞ x n , and y = limn !∞ y n , we have x % y .
Discontinuity: The preference relation % on X is
discontinuous if there exists a sequence of pairs f(x n , y n )gn∞=1
with x n % y n 8n 2 N, x = limn !∞ x n , y = limn !∞ y n , and
x y.

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Utility Function

A function u : X ! R is a utility function representing

preference relation % if

8x, y 2 X , x % y () u (x ) u (y )

Non-uniqueness
Ordinal property VS. Cardinal property

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Utility Representation

X Finite and % Rational =) % can be represented by a

utility function
X In…nite but Countable and % Rational =) % can be
represented by a utility function
If X is Separable:
% is Rational and Continuous () % can be represented by a
Continuous utility function
It is worth mentioning that "Preference is Rational but not
Continuous" only implies Preference cannot be represented by
a continuous Utility Function, it is still possible that Preference
can be represented by a discontinuous Utility Function.

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

The Relationship between Rationality and Utility

Representation

A Preference can be represented by a Utility Function =)

The preference must be Rational
The other way around is not true.
Counterexample: Lexicographic Preference

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Quasiconcave Preferences

Quasiconcavity
n function u ( ) is quasiconcave
A o if the set
L
y 2 R+ : u (y ) u (x ) is convex for all x, or equivalently if
u (αx + (1 α) y ) min fu (x ) , u (y )g 8x, y 2 R+ L
8α 2 [0, 1].
n function u ( ) is strictlyoquasiconcave if the set
A
L : u (y )
y 2 R+ u (x ) is strictly convex for all x, or
equivalently if u (αx + (1 α) y ) > min fu (x ) , u (y )g
8x, y 2 R+L , x 6 = y 8α 2 (0, 1).

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Lexicographic Ordering

2:
Lexicographic ordering on R+
8x, y 2 R+ , x % y () x1 > y1 or (x1 = y1 and x2
2 y2 ) .
Completeness
Transitivity
Strong Monotonicity
Strict Convexity
Local Nonsatiation
Re‡exivity
Antisymmetry
Discontinuity
No Utility Representation

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Homothetic Preferences

Homothetic: X = R+ L , all indi¤erence sets are related by

proportional expansion along rays

A continuous preference is homothetic () it admits a utility
function that is homogeneous of degree one
homogeneous of degree k
Examples:
Cobb-Douglas
Leontief
Linear
CES (Constant Elasticity of Substitution)

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Homothetic Preferences

Property 1:
x (p, αw ) = αx (p, w ) ) x (p, w ) = x (p, 1) w r (p ) w
Property 2:
v (p, αw ) = αv (p, w ) ) v (p, w ) = v (p, 1) w ε (p ) w
Properties 1 and 2 will be carefully studied in Lecture 3.

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Quasilinear Preferences

Quasilinear with respect to commodity 1 (numeraire

commodity): X = ( ∞, ∞) R+ L 1
,
(1) all indi¤erence sets are parallel displacements of each other
along the axis of commodity 1;
(2) commodity 1 is desirable
A continuous preference is quasilinear wrt commodity 1 ()
it admits a utility function of the form
u (x ) = x1 + v (x2 , x3 , xL )

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Quasilinear Preferences

Property 1: xi is a function of p and independent of w for

i = 2, , L 1, L.
Property 2:
α w
x (p, w + α) = x (p, w ) + p 1 e1 ) x (p, w ) = x (p, 0) + p 1 e1 ,
where e1 = (1, 0, , 0)T
w
Property 3: v (p, w ) = a (p ) + p1
Properties 1-3 will be carefully studied in Lecture 3.

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Choice Structure

Choice Structure (B ,C ( ))
B is a family of nonempty subsets of X
C ( ) is a choice rule (a correspondence) that assigns a
nonempty set of chosen elements C (B ) B 8B 2 B .

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Revealed Preferences

Revealed Preference denoted by %

Given (B ,C ( )),

x % y , 9B 2 B such that x, y 2 B and x 2 C (B )

Yan Lig Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

WARP

The Weak Axiom of Revealed Preference:

x % y =) y x
(9B 2 B such that x, y 2 B and x 2 C (B )) =) (8B 0 2 B
with x, y 2 B 0 , y 2 C (B 0 ) =) x 2 C (B 0 ))
y x =) x y
(9B 0 2 B with x, y 2 B 0 , y 2 C (B 0 ) and
x2/ C (B 0 )) =) (8B 2 B with x, y 2 B, x 2 / C (B ))
(9B 0 2 B with x, y 2 B 0 , y 2 C (B 0 ) and
x2/ C (B 0 )) =) (8B 2 B with x 2 C (B ), y 2 / B)
p x (p 0 , w 0 ) w and
x (p 0 , w 0 ) 6= x (p, w ) =) p 0 x (p, w ) > w 0

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

WARP and Rationality

Choice Structure satis…es WA and B includes all subsets of X

up to 3 elements =) the preference rationalizing C ( ) is
Rational and Unique.
Preference % is Rational =) Choice Structure generated by
% satis…es WA

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

SARP

The Strong Axiom of Revealed Preference:

x (p, w ) satis…es SA if for any list p 1 , w 1 , , pN , w N
with x p n +1 , w n +1 6= x (p n , w n ) 8n N 1, we have
p N x p 1 , w 1 > w N whenever p n x p n +1 , w n +1 wn
8n N 1
x (p, w ) satis…es SA =) x (p, w ) can be rationalized by a
rational preference relation.

Yan Li Microeconomics I, Lecture 1

 Agenda
Preferences and Basic Properties
Preference, Utility, and Choice Utility Representation
Special Preferences
Revealed Preferences

Lunch Time!
See You Next Week!

Yan Li Microeconomics I, Lecture 1