Checking the convexity and nonsatiation assumptions

EC201 LSE
Margaret Bray
October 25, 2009

Nonsatiation

1.1
1.1.1

The simple story

Definition and conditions for nonsatiation

Informally nonsatiation means that "more is better". This is not a precise statement, and it is possible
to work with a number of dierent definitions. For EC201
Nonsatiation means that utility can be increased by increasing consumption of one or both goods.
If the utility function is dierentiable you should test for nonsatiation by finding the partial derivatives of the utility function.
1.1.2

Example: testing for convexity with a Cobb-Douglas utility function

A Cobb-Douglas utility function has the form u(x1 , x2 ) = xa1 xb2 where a > 0 and b > 0. Here u(x1 , x2 ) =
2/5 3/5
x1 x2 . Assuming that x1 > 0 and x2 > 0 the partial derivatives are
u
x1
u
x2

=
=

2 3/5 3/5
x2 > 0
x
5 1
3 2/5 2/5
> 0.
x x
5 1 2

(1)
(2)

You should note that because the partial derivatives are both strictly1 positive utility is a strictly2
increasing function of both x1 and x2 when x1 > 0 and x2 > 0 so nonsatiation is satisfied.
1.1.3

Implications of nonsatiation

1. If utility is strictly increasing in both goods then the indierence curve is downward sloping
because if x1 is increased holding x2 constant then utility is increased, so it is necessary to reduce
x2 to get back to the original indierence curve.
2. If utility is strictly increasing in both goods then a consumer that maximizes utility subject to
the budget constraint and nonnegativity constraints will choose a bundle of goods which satisfies
the budget constraint as an equality so p1 x1 + p2 x2 = m, because if p1 x1 + p2 x2 < m it is possible
to increase utility by increasing x1 and x2 whilst still satisfying the budget constraint.
1A

number is strictly positive if it is greater than 0.



function is strictly increasing in x1 if when x01 > x1 and x2 is held constant at x
e2 then u x01 , x
e2 > u (x1 , x
e2 ).
The important point here is that the inequality > is strict.
2A

1.1.4

Nonsatiation with perfect complements utility

A utility function of the form u (x1 , x2 ) = min (a1 x1 , a2 x2 ) is called a perfect complements utility
function, but the partial derivative argument does not work because the partial derivatives do not exist
at a point where a1 x1 = a2 x2 which is where the solution to the consumers utility maximizing problem
always lie. This is discussed in consumer theory worked example 6

1.2
1.2.1

Nonsatiation: beyond EC201

Complications with the Cobb-Douglas utility function

A really detailed discussion of nonsatiation with Cobb-Douglas utility would note that the partial
derivative argument does not work at points where the partial derivatives do not exist. The partial
u
derivative
does not exist if x1 = 0 because the formula requires dividing by 0. Similarly the
x1
u
formula for
requires dividing by 0 if x2 = 0 so the function does not have a partial derivative with
x2
respect to x2 when x2 = 0.
However observe that if x1 = 0 or x2 = 0 then u(x1 , x2 ) = 0, whereas if
x1 > 0 and x2 > 0 then u(x1 , x2 ) > 0 so if one or both x1 and x2 is zero then increasing both x1 and x2
always increases utility. Thus nonsatiation holds for all values of x1 and x2 with x1 0 and x2 0.
1.2.2

More general formulations

u
u
> 0 and
> 0 implies nonsatiation. However these conditions can be
x1
x2
weakened considerably without losing the implication that the consumer maximizes utility by choosing
a point on the budget line which is what really matters. For example if utility is increasing in good 1
but decreasing in good 2 so good 2 is in fact a "bad" the consumer maximizes utility by spending all
income on good 1 and nothing on good 2.

The condition that

2
2.1
2.1.1

Convexity and concavity

Concepts
Convex sets

A set is convex if the straight line joining any two points in the set lies entirely within the set. Figure
1 illustrates convex and non-convex sets.
2.1.2

Convex functions

A function is convex if the straight line joining any two points on the graph of the function lies entirely
on or above the graph as illustrated in figure 2. Another way of looking at convex functions is that they
are functions for which the set of points lying above the graph is convex. Figure 2 suggests that if the
first derivative of a function does not decrease anywhere then the function is convex. This suggestion
is correct. If the function has a second derivative that is positive or zero everywhere then the first
derivative cannot decrease so the function is convex. This gives a way of testing whether a function
is convex. Find the second derivative; if the second derivative is positive or zero everywhere then the
function is convex.
2.1.3

Concave functions

Concave functions are important in the theory of the firm. A function is concave if the straight line
joining any two points on the graph of the function lies entirely on or below the graph as illustrated
in figure 3. Another way of looking at concave functions is that they are functions for which the set
of points lying below the graph is convex. Figure 3 suggests that if the first derivative of a function
does not increase anywhere then the function is concave. This suggestion is correct. If the function

Convexity
Mathematically a set is convex if any straight line joining
two points in the set lies in the set.
Which of these sets are convex?

non-convex

convex

convex

non-convex

Figure 1: Convex sets

A function is convex if a straight line

joining two points on its graph lies
entirely on or above the function.
If the second derivative of the function
is positive or zero at every point then

x2

the function is convex.

x1

Figure 2: A convex function

A func tio n is c on ca ve if a s tra ight lin e

joining tw o po ints on its g ra ph lies
en tirely o n or be low the fun ction .
If the s ec on d de riva tiv e o f the fun ction
is ne ga tive or zero a t e very p oint the n

x2

the fun ction is c on ca ve .

ca ve

x1

Figure 3: A concave function

has a second derivative that is negative or zero everywhere then the first derivative cannot increase so
the function is concave. This gives a way of testing whether a function is convex. Find the second
derivative; if the second derivative is negative or zero everywhere then the function is concave.
You may find it easier to remember the dierence between convex and concave functions if you think
that a function is concave if it has a cave underneath it.

2.2
2.2.1

Convexity in consumer theory

Definition

The convexity assumption in consumer theory is that for any (x10 , x20 ) the set of points for which
u(x1 , x2 ) u (x10 , x20 ) is convex. If utility is strictly increasing in both x1 and x2 so the indierence
curve slopes downwards the convexity assumption is is equivalent to an assumption that thinking of the
indierence curve as the graph of a function that gives x2 as a function of x1 the function is convex.
u
u
> 0 and
> 0 so the indierence
Thus if the test for nonsatiation establishes that both
x1
x2
curves are downward sloping the convexity assumption can be tested by rearranging the equation for an
indierence curve to get x2 as a function of x1 and u, and then finding whether the second derivative
2 x2
> 0.
x2
1

2.2.2

Example: testing for convexity with a Cobb-Douglas utility function

2/5 3/5

Here u(x1 , x2 ) = x1 x2 . Write

2/5 3/5

u = x1 x2 .

(3)

Rearranging to get x2 as a function of x1 and u

2/3

x2 = u5/3 x1

Holding u constant so staying on the same indierence curve

x2
2
5/3
= u5/3 x1
x1
3
and

10 5/3 8/3
2 x2
=
>0
u x1
x21
9

(4)

u
u
> 0 and
> 0 the indierence
x1
x2
curve is downward sloping and the preferred set is above the indierence curve so the convexity condition
is satisfied.
so on an indierence curve x2 is a convex function of x1 . Because

2.2.3

Algebra problems

You should know how to rearrange equation 3 to get equation 4. If this is causing you problems note
firstly that equation 3 implies that

5/3
2/5 3/5
2/3
u5/3 = x1 x2
= x1 x2

so

x2 =

2.3

u5/3
2/3
x1

2/3

= u5/3 x1

Beyond EC201

Concavity and convexity can be defined algebraically and this is essential if you want to prove any
results about concavity and convexity rather than appealing to intuition as I have done here. The
procedure I have given for checking the convexity condition in consumer theory requires that the first
u
u
derivatives
> 0 and
> 0 and does not work with more than two goods. There is a much
x1
x2
more general method; write down the matrix of second derivatives of the function u (x1 , x2 ). If this
matrix is positive semidefinite everywhere the function is convex, if the matrix is negative semidefinite
everywhere the function is concave. You do not need to know about this for EC201.