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In this case, we cannot construct a continuous utility function. That is why we are
ruling out indivisible goods.
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The set in the top panel above is convex, because any point along the line
connecting two points in the set is also in the set. However, the crescent is not a
convex set, because some points along the line connecting a and b are not in the
set.
The interior of the Chinese word meaning convex below is not a convex set.
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Notation
Symbols Meaning
“implies”
“is implied by”
iff (if, and only if)
/ Not
There exists
There does not exist
For all
Is an element of
Is not an element of
P Is preferred to
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I Is indifferent to
R Is as good as
Two distinct bundles have different quantities of various goods. When one
bundle dominates another, the choice is easy and everybody will make the same
choice. When neither of two bundles dominates the other, the choice is more
difficult.
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If one bundle dominates another, then the ranking of consumption bundles is
simple. All consumers prefer the dominating bundle. In Figure 3, any bundle in
the blue region dominates bundle a, whereas bundle a dominates any bundle in
the green region.
However, life is not that simple. Compare bundle a and the bundles in the white
regions. Neither dominates the other. Some consumers prefer b to a, while others
prefer a to b. This is usually the case for managers. If there is a clear dominating
choice, the manager must choose the dominating option. In all other cases, the
manager must choose between options in which neither dominates the other.
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Axioms of Consumer Preference
1. Completeness
a P b, b P a, or a I b. (a R b, or b R a)
Given any two choices (commodity bundles), one of the following is true.
In other words, given any two alternatives, the consumer is assumed to be able to
rank them.
2. Reflexivity
a I a.
3. Transitivity
a P b, b P c a P b.
a I b, b I c a I c.
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U() is a utility function, if
Existence
Does there exist such a utility function? Yes, if consumer preferences satisfy
completeness, reflexivity and transitivity.
Method: Draw a 45 degree line from the origin. If bundle a is not on the 45
degree line, then locate a bundle b which is indifferent to a, and assign the same
utility index, i.e., u(a) = u(b).
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For any point along the 45 degree line, use the distance from the origin.
u ( x1 , x2 ) = x12 + x22 .
Now this distance function qualifies as a utility index. Moreover, you can
construct many others. Let
v = f (u )
v = u 2 = x12 + x22
Continuity
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Figure 4. Continuity of Preference
There are some preferences that violate the assumption of continuity. One
famous counterexample is called lexicographic ordering.
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Lexicographic preferences take their name from the dictionary, where words
appear in alphabetical order.
When arranging words alphabetically, we first compare their first letters, not
paying attention to all other letters. When comparing two words, we first
compare the first letters of two words and rank them. For instance, given two
words, “car” and “apple,” apple precedes car because a precedes c. In this we do
not worry about the second or third letters in the two words.
When the two words have the same first letters, then we compare the second
letters and rank the words. For instance, “car” and “cold” have the same first
letter c. Then we proceed to compare the second letter, and rank words
accordingly. Thus, “car” precedes “cold.” If the second letters are the same, then
compare the third letters, and so on.
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Figure 5 illustrates lexicographic ordering.
In Figure 5, honor is the primary good and gold is the secondary good. This
consumer always looks for honor first, and then compares gold. Among the three
bundles, A precedes B and B precedes C. Among the points on the line
connecting A and C, one cannot draw an indifference curve through the middle
point B. (The vertical line which starts at point B is not an indifference curve,
because all points on this line is preferred to B.) Thus, a continuous utility
function cannot be constructed for lexicographic preferences.
If x is an integer, then
y
U ( x, y ) = x +
y +1
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is a utility function that represents lexicographic preferences. This is because
y /( y + 1) is always smaller than one. However, it is not a continuous utility
function. It is a utility function, but it does not have indifference curves.
(Why make a big deal about continuity? Continuous utility functions are
differentiable. Hence they facilitate optimization to be discussed later)
u ( x, y ) = x + by, b > 0.
The concepts of utility functions are somewhat more complicated than they
appear at first glance.
For choices without uncertainty, we need only ordinal utility functions to explain
consumer choice. If consumer choice is made under conditions of uncertainty, a
cardinal utility function is needed.
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Additional assumptions
u ( x, y , z ),
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Convexity of Preferences
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