Properties of Utility Functions

Econ 2100, Fall 2012

Lecture 4, 6 September
Outline
1
Structural Properties of Utility Functions
1 Monotonicity
2 Convexity
3 Quasi-linearity
From Last Class
Utility Representation
Theorem (Debreu)
Suppose X _ R
n
. The binary relation % on X is complete, transitive, and
continuous if and only if there exists a continuous utility representation u : X R.
Choices are actions that maximize utility for a given budget.
Proposition
If % is a continuous preference relation and A _ R
n
is nonempty and compact,
then C
%
(A) is nonempty and compact:
C
%
(A) = arg max
x2A
u(x):
Where the induced choice rule (
%
is dened by
(
%
(A) = x A : x % y for all y A
Structural Properties of Utility Functions
Aside from existence and continuity, further restrictions on the utility function are
often useful.
From now on, assume X = R
n
.
If x
i
_ y
i
for each i , we write x _ y.
The idea is to connect properties of preferences with properties of the utility
function that represents them.
Monotonicity
Denition
A preference relation % is weakly monotone if x _ y implies x % y.
A preference relation % is strictly monotone if x _ y and x = y imply x ~ y.
Monotonicity says more is better.
Monotonicity: An Example
Example
Suppose % is the preference relation dened on R
2
dened by x % y if and only if
x
1
_ y
1
.
This % is weakly monotone, because if x _ y, then x
1
_ y
1
.
It is not strictly monotone, because (1; 1) _ (1; 0) and (1; 1) = (1; 0), yet
not(1; 1) ~ (1; 0) since (1; 0) % (1; 1).
Strict Monotonicity: An Example
Example
The lexicographic preference on R
2
is strictly monotone.
Proof: Suppose x _ y and x = y.
Then either (a) x
1
> y
1
and x
2
_ y
2
or (b) x
1
_ y
1
and x
2
> y
2
.
If (a) holds, then
x % y because x
1
y
1
,
and noty % x because neither y
1
> x
1
(excluded by x
1
> y
1
) nor y
1
= x
1
(also
excluded by x
1
> y
1
).
If (b) holds, then
x % y because either x
1
> y
1
or x
1
= y
1
and x
2
y
2
.
and noty % x because noty
1
> x
1
(excluded by x
1
y
1
) and noty
2
x
2
(excluded by x
2
> y
2
).
Monotonicity and Utility Functions
Denition
A function f : R
n
R is
nondecreasing if x _ y implies f (x) _ f (y);
strictly increasing if x _ y and x = y imply f (x) > f (y).
Monotonicity is equivalent to nondecreasing corresponding utility function
being 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.
Question 5a. Problem Set 2, due next Tuesday.
Local Non Satiation
Denition
A preference relation % is locally nonsatiated if for all x X and " > 0, there
exists some y such that |y x| < " and y ~ x.
For any consumption bundle there is always a nearby bundle that is strictly
preferred to it.
Denition
A utility function u : X R is locally nonsatiated if it represents a locally
nonsatiated preference relation %, i.e. if for every x X and " > 0, there exists
some y such that |y x| < " and u(y) > u(x).
Example
The lexicographic preference is locally nonsatiated.
Proof:
Fix (x
1
; x
2
) and " > 0.
Then (x
1
+
"
2
; x
2
) satises |(x
1
+
"
2
; x
2
) (x
1
:x
2
)| < " and (x
1
+
"
2
; x
2
) ~ (x
1
; x
2
).
Local Non Satiation
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 y
i
> x
i
for each i .
Strict monotonicity implies that y ~ x.
Note that
[[y x[[ =
v
u
u
t
n
X
i =1

"
n

2
=
"

n
< ":
Thus % is locally nonsatiated.
Shapes of Utility Functions
Denition
Suppose C is a convex subset of X. A function f : C R is:
concave if f (x + (1 )y) _ f (x) + (1 )f (y), for all [0; 1] and
x; y C;
strictly concave if f (x + (1 )y) > f (x) + (1 )f (y), for all (0; 1)
and x; y X such that x = y;
convex if f (x + (1 )y) _ f (x) + (1 )f (y), for all [0; 1] and
x; y C;
strictly convex if f (x + (1 )y) < f (x) + (1 )f (y), for all (0; 1)
and x; y C such that x = y;
ane if f is concave and convex, i.e.
f (x + (1 )y) = f (x) + (1 )f (y), for all [0; 1] and x; y C;
quasiconcave if f (x) _ f (y) implies f (x + (1 )y) _ f (y), for all
[0; 1];
strictly quasiconcave if f (x) _ f (y) and x = y imply
f (x + (1 )y) > f (y), for all (0; 1).
Convex Preferences
Denition
A preference relation % is convex if
x % y = x + (1 )y % y for all (0; 1)
A preference relation % is strictly convex if
x % y and x = y = x + (1 )y ~ y for all (0; 1)
Convexity says that taking convex combinations cannot make the decision
maker worse o.
Strict convexity says that taking convex combinations makes the decision
maker better o.
Convex Preferences: An Example
Example
% on R
2
dened by x % y if and only if x
1
+ x
2
_ y
1
+ y
2
is convex.
Proof: Suppose x % y, i.e. x
1
+ x
2
_ y
1
+ y
2
, and x (0; 1).
Then
x + (1 )y = (x
1
+ (1 )y
1
; x
2
+ (1 )y
2
)
So,
[x
1
+ (1 )y
1
] + [x
2
+ (1 )y
2
] = [x
1
+ x
2
| {z }
y
1
+y
2
] + (1 )[y
1
+ y
2
]
_ [y
1
+ y
2
] + (1 )[y
1
+ y
2
]
= y
1
+ y
2
;
proving x + (1 )y % y.
This is not strictly convex, because (1; 0) % (0; 1) and (1; 0) = (0; 1) but
1
2
(1; 0) +
1
2
(0; 1) = (
1
2
;
1
2
) % (0; 1):
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.
Question 5b. Problem Set 2, due next Tuesday.
Quasiconcave Utility and Convex Upper Contours
Proposition
Let % be a preference relation on X represened by u : X R. Then, the upper contour set of z
is a convex subset of X if and only if u is quasiconcave.
Proof.
Suppose that u is quasiconcave.
Fix z X, and take any x; y % (z).
Wlog, assume u(x) _ u(y), so that u(x) _ u(y) _ u(z), and let [0; 1].
By quasiconcavity of u,
u(z) _ u(y) _ u(x + (1 )y);
so x + (1 )y % z.
Hence x + (1 )y belongs to % (z), proving it is convex.
Now suppose that % (z) is convex for all z X.
Let x; y X and [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 x + (1 )y % y.
Since u represents %,
u(x + (1 )y) _ u(y):
Thus u is quasiconcave.
Convexity and 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 (
%
(A).
By denition of (
%
(A), x % y.
Since A is convex: x + (1 )y A for any [0; 1].
Convexity of % implies x + (1 )y % y.
By denition of (
%
, y % z for all z A.
Using transitivity, x + (1 )y % y % z for all z A.
Hence, x + (1 )y (
%
(A) by denition 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 (
%
(A) with x = y.
Since x % y and x = y, strict convexity implies x + (1 )y ~ y for all (0; 1).
Since A is convex, x + (1 )y A, but this contradicts the fact that y (
%
(A).
Quasi-linear Utility
Denition
The function u : R
n
R is quasi-linear if there exists a function v : R
n1
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 R
n
admits a quasi-linear representation if and only
1
(x; m) % (x; m
0
) if and only if m _ m
0
, for all x R
n1
and all m; m
0
R;
2
(x; m) % (x
0
; m
0
) if and only if (x; m + m
00
) % (x
0
; m
0
+ m
00
), for all x R
n1
and m; m
0
; m
00
R;
3
for all x; x
0
R
n1
, there exist m; m
0
R such that (x; m) ~ (x
0
; m
0
).
1
Given two bundles with identical goods, the consumer always prefers with
more money.
2
Rules out wealth eects: adding (or subtracting) the same monetary amount
to (or from) each bundle does not aect their ordering.
3
Monetary transfers can be used to achieve indierence between any two
bundles.
Proof.
Fix some x
0
R
n1
.
For every x R
n1
, there exist n; n
0
R such that (x; n) ~ (x
0
; n
0
), by (3).
Subtract n
0
from both sides and apply (2), so that (x; n n
0
) ~ (x
0
; 0).
Dene v(x) = n
0
n, and thus (x; v(x)) ~ (x
0
; 0).
Now add m + v(x) to both sides and apply (2) again:
(x; m) ~ (x
0
; m + v(x)) (A)
for any m R.
Then
(x; m) % (x
0
; m
0
) =(x; m v(x) v(x
0
))
| {z }
(x
0
;mv(x
0
))
% (x
0
; m
0
v(x) v(x
0
))
| {z }
(x
0
;mv(x))
; by (2)
=(x
0
; m v(x
0
)) % (x
0
; m
0
v(x)); by (A)
=m v(x
0
) _ m
0
v(x); by (2)
=v(x) + m _ v(x
0
) + m
0
:
Quasi-linear Preferences and Utility
Quasi-linear utility representations are unique up to a constant.
Proposition
Suppose that the preference relation % on R
n
admits two quasi-linear
representations: v(x) + m, and v
0
(x) + m, where v; v
0
: R
n1
R. Then there
exists c R such that v
0
(x) = v(x) c for all x R
n1
.
Proof.
Let v(x) + m and v
0
(x) + m both represent %.
Given any x
0
R
n1
, for all x R
n1
there exists n
x
such that (x; 0) ~ (x
0
; n
x
).
(by (2) and (3) of the previous Proposition.)
Since the utility functions both represent % we have
v(x) = v(x
0
) + n
x
and v
0
(x) = v
0
(x
0
) + n
x
Thus n
x
= v
0
(x) v
0
(x
0
). Therefore
v(x) = v(x
0
) + v
0
(x) v
0
(x
0
)
| {z }
=n
x
Hence, for all x R
n1
,
v(x) v
0
(x) =
a constant c
z }| {
v(x
0
) v
0
(x
0
) = v
0
(x) = v(x) c:
Homothetic Preferences and Utility
Homothetic preferences are also useful in many applications, in particular for
aggregation problems.
Denition (Homothetic preferences)
The preference relation % on X is homothetic if for all x; y X,
x ~ y =x ~ y for each > 0
Proposition
The continuous preference relation % on R
n
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 (x) =
r
f (x) for any x and > 0.
Proof.
Question 5c. Problem Set 2, due next Tuesday.
Problem Set 2
Due Tuesday, 12 September, at the beginning of class
1
Suppose u : X R represents %. Then v : X R represents % if and only if
there exists a strictly increasing function h : u(X) R such that v = h u.
1
2
Suppose X is countable. Then % is a preference relation if and only if there
exists some utility function u : X R that represents %.
3
Prove that if u : X R is a continuous utility function representing % then %
is a continuous preference relation.
4
Construct a preference relation on R that is not continuous, but admits a
utility representation.
5
Prove that if u represents %, then:
1 % is weakly monotone if and only if u is nondecreasing;
% is strictly monotone if and only if u is strictly increasing.
2 % is convex if and only if u is quasiconcave;
% is strictly convex if and only if u is strictly quasiconcave.
3 a continuous % is homothetic if and only if it is represented by a utility
function that is homogeneous of degree 1.
1
Suppose Z R. The function h : Z !R is strictly increasing if h(z) > h(z
0
) for all z; z
0
2 Z
such that z > z
0
.