Chapter 4

Review: Utility

A utility function is a way of assigning a number to every possible con-

sumption bundle such that more-preferred bundles get assigned larger num-
bers than less-preferred bundles.Tht is, (x1 , x2 ) Â (y1 , y2 ) if and only if
u(x1 , x2 ) > u(y1 , y2 ).
The only property of a utility assignment that is important is how it it
orders or ranks the bundles of goods; the actual size of the utility difference
between any tow consumption bundles doesn’t matter. This kind of utility
is known as ordinal utility.
A monotonic transformation is way of transforming one set of num-
bers into another set of numbers in a way that preserves the order of the
numbers. Examples of (positive) monotonic transformation are multiplica-
tion by some positive number (e.g., f (u) = 3u), adding a constant (e.g.,
f (u) = u + 15), raising u to an odd power (f (u) = u3 ), etc.
The rate of change of f (u) as u changes can be measured by looking at
the change in f between two values of u, divided by the change in u:

4f f (u2 ) − f (u1 )
=
4u u2 − u1
For a monotonic transformation, f (u2 )−f (u1 ) always has the same sign
as u2 − u1 .

1
2 CHAPTER 4. REVIEW: UTILITY

If f (u1 ) is any monotonic transformation of of a utility function that

represents seme particular preferences, then f (u(x1 , x2 )) is also a utility
function that represents those same preferences.

4.1 Some examples of utility functions

1. Perfect substitutes: u(x1 , x2 ) = x1 +x2 or any monotonic transformation
of this, such as ln(xi + x2 ).

2. Perfect complements: u(x1 , x2 ) = min(x1 , x2 ) or any monotonic trans-

formation of this, such as min(axi +bx2 ), where a and b are some constants.

3. Quasilinear preferences: u(x1 , x2 ) = v(x1 ) + x2 .

4. Cobb-Douglas preferences: u(x1 , x2 ) = xa1 xb2 . A convenient transforma-

tion is u(x1 , x2 ) = a ln x1 + b ln x2 and also u(x1 , x2 ) = xa1 x1−a
2 .

4.2 Marginal utility

The rate of change in utility associated by a small change in the amount of
a good is called the marginal utility,

4U u(x1 + 4x1 , x2 ) − u(x1 , x2 )

M U1 = =
4x1 4x1
Actually, we can take the limit when 4x1 → 0. Symbolically, using partial
derivatives the marginal utility of good 1 holding good 2 fixed can be written
as

u(x1 + 4x1 , x2 ) − u(x1 , x2 ) ∂(x1 , x2 )

M U1 = lim =
4x1 →0 4x1 ∂x1

4.3 Marginal utility and MRS

Consider a small change in the consumption of each good (4x1 , 4x2 ) that
keep utility constant - i.e. a change in consumption that moves the con-
4.4. OTHER METHODS TO ARRIVE AT THE MRS 3

sumer along the indifference curve. Then we must have

M U1 4x1 + M U2 4x2 = 4M U = 0

Hence, solving for the slope of the indifference curve gives

4x2 M U1
M RS = = (4.1)
4x1 M U2

4.4 Other methods to arrive at the MRS

For the above, another way to derive the MRS and this time using partial
derivatives, we can think of indifference curves as being described by the
function x2 (x1 ). That is, for each value of x1 , the function x2 (x1 ) tells us
how much x2 we need to get on that specific indifference curve. Thus the
function x2 (x1 ) must satisfy the identity

u(x1 , x2 (x1 )) ≡ k

where k is some constant utility of the indifference curve under considera-

tion.
We can differentiate both sides of this identity with respect to x1 to get

∂u(x1 , x2 ) ∂u(x1 , x2 ) ∂x2 (x1 )

+ =0
∂x1 ∂x2 ∂x1
Then we get

∂x2 (x1 ) ∂u(x1 , x2 )/∂x1

=−
∂x1 ∂u(x1 , x2 )/∂x2
just as before.
The implicit function method is a little more rigorous. Suppose that
we take a monotonic transformation of a utility function, say, v(x1 , x2 ) =
f (u(x1 , x2 )). Using the chain rule
4 CHAPTER 4. REVIEW: UTILITY

∂v/∂x1 ∂f /∂u ∂u/∂x1

M RS = − =−
∂v/∂x2 ∂f /∂u ∂u/∂x2
∂u/∂x1
=−
∂u/∂x2
since the ∂f /∂u term cancels out. This shows that the MRS is independent
of the utility representation.

4.5 Example with Cobb-Douglas preferences

Given Cobb-Douglas preferences, that is,

u(x1 , x2 ) = xα1 xβ2

we have

∂u(x1 , x2 )/∂x1
M RS = −
∂u(x1 , x2 )/∂x2
αxα−1
1 xβ2
=
βxβ−1
2 xα1
αx2
=−
βx1
Similarly, taking logs, we could write

u(x1 , x2 ) = α ln x1 + β ln x2
then we get

∂u(x1 , x2 )/∂x1
M RS = −
∂u(x1 , x2 )/∂x2
α/x1 αx2
= =−
β/x2 βx1
4.5. EXAMPLE WITH COBB-DOUGLAS PREFERENCES 5

Same as before (of course, since a monotonic transformation will result in

same MRS!)