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You are on page 1of 23

Lecture 7, September 19

Outline

1 Comparative Statics Without Calculus

2 Supermodularity and Single Crossing

3 Topkis and Milgrom&Shannons Theorems

4 Finite Data

Comparative Statics Without Calculus

Remark

Let x (q) = arg max f (x; q); subject to q 2 , x 2 S(q)

Using the implicit function theorem, one can show that if there are

complementarities between the choice variable x and the parameter q, the

optimum increases in q.

First Order Condition: fx (x; q) = 0. Second Order Condition: fxx (x; q) < 0.

IFT: fxq (x; q)

xq (q) = :

fxx (x; q)

Then

xq (q) 0 if and only if fxq (x; q) 0

Issues with implicit function theorem:

1 IFT needs calculus.

2 Conclusions hold only in a neighborhood of the optimum.

3 Results are dependent on the functional form used for the objective function.

1 In particular, IFT gives cardinal results that depend on the assumptions on f .

Monotone Comparative Statics

Objectives

With monotone comparative statics, we have results about changes that:

do not need calculus;

are not necessarily only local (around the optimum);

are ordinal in the sense of being robust to monotonic transformations.

The downside is that the results are not as strong.

The central idea generalizes the notion of complementarities between

endogenous variable and parameters.

With calculus, this is the assumption fxq (x ; q) 0.

We would also like to account for the possibility that the optimum is not

unique, so that x (q) is not a function.

First, what does it mean for a correspondence to be increasing?

Strong Set Order

Ranking real numbers is easy, but how can we express the idea that one set is

bigger than another set?

Denition

For two sets of real numbers A and B, dene the binary relation s as follows:

for any a 2 A and b 2 B

A sB if

minfa; bg 2 B and maxfa; bg 2 A

A s B reads A is greater than or equal to B in the strong set order.

This denition reduces to the standard denition when sets are singletons.

Example

Suppose A = f1; 3g and B = f0; 2g. Then, A is not greater than or equal to B in

the strong set order.

Non-Decreasing Correspondences

Denition

We say a correspondence g : Rn ! 2R is non-decreasing in q if and only if

x0 > x implies g (x 0 ) s g (x)

Thus, x 0 > x implies that for any y 0 2 g (x 0 ) and y 2 g (x): minfy 0 ; y g 2 g (x)

and maxfy 0 ; y g 2 g (x 0 ).

Larger points in the domain correspond to larger sets in the codomain.

Generalizes the notion of increasing function to correspondences.

Exercise

Prove that if g ( ) is non-decreasing and min g (x) exists for all x, then min g (x) is

non-decreasing.

Exercise

Prove that if g ( ) is non-decreasing and max g (x) exists for all x, then max g (x) is

non-decreasing.

Monotone Comparative Statics: Simplest Case

Set up

Suppose the function f : R2 ! R is the objective function; this is not

necessarily concave or dierentiable, and the optimizer could be set valued.

Let

x (q) = arg max f (x; q); subject to q 2 ; x 2 S(q)

Note: for any strictly increasing h, this problem is equivalent to

x (q) = arg max h(f (x ; q)); subject to q 2 ; x 2 S (q)

h( ) may destroy smoothness or concavity properties of the objective function so

IFT may not work.

For now, assume S( ) is independent of q (ignore the constraints), and that

both x and q are real variables.

Assume existence of a solution, but not uniqueness.

Supermodularity

Denition

The function f : R2 ! R is supermodular in (x; q) if

for all x 0 > x f (x 0 ; q) f (x; q) is non-decreasing in q:

greater when q is higher.

This is the idea that x and q are complements.

Show that supermodularity is equivalent to the property that

q0 > q implies f (x; q 0 ) f (x; q) is non-decreasing in x:

Dierentiable Version of Supermodularity

derivatives.

Lemma

A twice continuously dierentiable function f : R2 ! R is supermodular in (x; q) if

and only if Dxq f (x; q) 0 for all (x; q).

of the mixed-partial condition in the lemma.

q0 > q implies f (x ; q 0 ) f (x ; q) is non-decreasing in x

TopkisMonotonicity Theorem

Theorem (Easy TopkisMonotonicity Theorem)

If f is supermodular in (x; q), then x (q) = arg max f (x; q) is non-decreasing.

Proof.

Let q 0 > q and take x 2 x (q) and x 0 2 x (q 0 ). Show that x (q 0 ) s x (q).

0 0

First show that maxfx; x g 2 x (q )

x 2 x (q) implies f (x ; q) f (minfx ; x 0 g; q) 0.

x 2 x (q) also implies that f (maxfx ; x 0 g; q) f (x 0 ; q) 0

verify these by checking two cases, x > x0 and x0 > x.

0 0 0 0

By supermodularity, f (maxfx ; x g; q ) f (x ; q ) 0,

Hence maxfx ; x 0 g 2 x (q 0 ).

Now show that minfx; x 0 g 2 x (q)

maxfx ; x 0 g 2 x (q 0 ) implies that f (x 0 ; q 0 ) f (maxfx ; x 0 g; q) 0,

or equivalently f (maxfx ; x 0 g; q) f (x 0 ; q 0 ) 0.

maxfx ; x 0 g 2 x (q 0 ) also implies that f (maxfx ; x 0 g; q 0 ) f (x 0 ; q 0 ) 0,

which by supermodularity implies f (x ; q) f (minfx ; x 0 g; q) 0

Hence minfx ; x 0 g 2 x (q).

TopkisMonotonicity Theorem

If f is supermodular in (x; q), then x (q) = arg max f (x; q) is non-decreasing.

optimization problems without other assumptons.

TopkisTheorem follows from the IFT whenever the standard full-rank

condition in the IFT holds.

At a maximum, if Dxx f (x ; q) 6= 0, it must be negative (by the second-order

condition), hence the IFT tells you that x (q) is strictly increasing.

Example

A monopolist chooses output q to solve max p(q)q c(q; ).

p( ) is the demand (price) function

c( ) is the cost function

costs depend on the existing technology, described by some parameter .

Suppose c(q; ) is supermodular in (q; ); then the entire objective function

is also supermodular in (q; ).

this follows because the rst term of the objective does not depend on .

Notice that supermodularity says that for all q 0 > q, c(q 0 ; ) + c(q; ) is

nondecreasing in .

in other words, the marginal cost is decreasing in .

Conclusion: by Topkistheorem q is nondecreasing as long as the marginal

cost of production decreases in the technological progress parameter .

Single-Crossing

In constrained maximization problems, x 2 S(q), supermodularity is not

enough for Topkistheorem.

Denition

The function f : R2 ! R satises the single-crossing condition in (x; q) if for all

x 0 > x, q 0 > q

f (x 0 ; q) f (x; q) 0 implies f (x 0 ; q 0 ) f (x; q 0 ) 0

and

f (x 0 ; q) f (x; q) > 0 implies f (x 0 ; q 0 ) f (x; q 0 ) > 0:

As a function of the second argument, the marginal return can cross 0 at most

once; whenever it crosses 0, as the second argument continues to increase, the

marginal return is going to remain positive.

Theorem

If f satises single crossing in (x; q), then x (q) = arg maxx 2S (q) f (x; q) is

nondecreasing. Moreover, if x (q) is nondecreasing in q for all constraint choice

sets S, then f satises single-crossing in (x; q).

Monotone Comparative Statics

n-dimensional choice variable and m-dimensional parameter vector

Denitions

Suppose x; y 2 Rn .

The join of x and y is dened by

x _ y = (maxfx1 ; y1 g; maxfx2 ; y2 g; : : : ; maxfxn ; yn g):

The meet of x and y is dened by

x ^ y = (minfx1 ; y1 g; minfx2 ; y2 g; : : : ; minfxn ; yn g):

Draw a picture.

Strong Set Order

The binary relation s is dened as follows: for A; B Rn ,

for any a 2 A and b 2 B

A sB if

a^b 2B and a _ b 2 A

The meet is in the smaller set, while the join is in the larger set.

One uses this to talk about non-decreasing Rn -valued correspondences.

endogenous variables and the second represents the parameters.

Quasi-Supermodularity

Denition

The function f : Rn Rm ! R is quasi-supermodular in its rst argument if, for all

x; y 2 Rn and q 2 Rm :

1 f (x; q) f (x ^ y; q) ) f (x _ y; q) f (y; q);

2 f (x; q) > f (x ^ y; q) ) f (x _ y; q) > f (y; q):

statements about complementarities.

Quasi-supermodularity is an ordinal property; for dierentiable functions there

is a su cient condition for quasi-supermodularity.

Exercise

1 Prove that if f is quasi-supermodular in x, then h f is quasi-supermodular in

x for any strictly increasing h : f (Rn Rm ) ! R.

@2 f

2 Suppose f (x; q) is twice dierentiable in x and @xi xj > 0 for all i; j = 1; : : : ; n

with i 6= j. Then f is quasi-supermodular in x.

Single-Crossing Property

Denition

The function f : Rn Rm ! R satises the single-crossing property if, for all

x; y 2 Rn and q; r 2 Rm such that x y and q r:

1 f (x; r) f (y; r) ) f (x; q) f (y; q);

2 f (x; r) > f (y; r) ) f (x; q) > f (y; q):

can cross 0 at most once.

The single-crossing property is an ordinal property; for dierentiable functions

there is a su cient condition for single-crossing.

Exercise

1 Prove that if f satises the single-crossing property, then h f satises the

single-crossing property for any strictly increasing h : f (Rn Rm ) ! R.

2

@ f

2 Suppose f (x; q) is twice dierentiable and @x i xj

> 0 for all i = 1; : : : ; n and

j = 1; : : : ; m. Then f satises the single-crossing property.

Monotone Comparative Statics

Theorem (easy Milgrom and Shannon)

Let f : Rn Rm ! R. Dene x (q) = arg maxx 2R n f (x; q). Suppose jx (q)j = 1

for all q and f (x; q) is quasi-supermodular in its rst argument and satises the

single-crossing property. Then

q r ) x (q) x (r ):

Easybecause it assumes the optimum is unique (thus, the proof does not use

strictquasi-supermodularity and single-crossing).

Proof.

Suppose q r . Then:

f (x (r ); r ) f (x (q) ^ x (r ); r ) by denition of x (q)

) f (x (q) _ x (r ); r ) f (x (q); r ) by quasi-supermodularity in x

) f (x (q) _ x (r ); q) f (x (q); q) by Single Crossing

) x (q) _ x (r ) = x (q) since jx (q)j equals 1

) x (q) x (r ) by Question 2, PS4

Problem Set 4), and to multi-valued optimizers (see Milgrom & Shannon).

Data and Rationality: Motivation

Main Idea

We observe data and want to know if it could have been the result of

maximizing a preference relation or a utility function.

We observe N consumption choices made by an individual, given her income

and prices (also observable):

x 1 ; p1 ; w 1 x 2 ; p2 ; w 2 x 3 ; p3 ; w 3 ::: x N ; pN ; w N

These satisfy:

(x j ; p j ; w j ) 2 Rn+ Rn++ R+ for all j = 1; ::; N; and

p j x j w j for all j = 1; ::; N.

In other words, we have nitely many observations on behavior.

What conditions must these observations satisfy for us to conclude they are

the result of the maximizing of a preference relation or a utility function?

Answer: Something similar to, but stronger than, revealed preference.

An Example (from Kreps)

Suppose we observe the following choices among 3 goods

w p x

1 300 (10; 10; 10) (10; 10; 10)

2 130 (10; 1; 2) (9; 25; 7:5)

3 110 (1; 1; 10) (15; 5; 9)

function that generates these choices?

Sure: suppose the consumer strictly prefers (500; 500; 500) to anything else,

and is indierent among all other bundles.

Since (500; 500; 500) is never aordable, any other choice is rationalizable.

This seems silly, and not something that should worry us since we can never rule

it out.

We may want at least local non satiation.

Observations:

The consumer spends all her income in all cases. Furthermore:

At prices (10; 10; 10) the bundle (15; 5; 9) could have been chosen.

At prices (10; 1; 2) the bundle (10; 10; 10) could have been chosen.

At prices (1; 1; 10) the bundle (9; 25; 7:5) could have been chosen.

Consequences of Local Non Satiation

The following is slightly dierent from Full Expenditure.

Lemma

Suppose % is locally non-satiated, and let x be an element of Walrasian demand

(therefore x % x for all x 2 fx 2 X : p x w g). Then

x %x when p x =w

and

x x when p x <w

The maximal bundle is weakly preferred to any bundle that costs the same.

The maximal bundle is strictly preferred to any bundle that costs less.

Proof.

The rst part is immediate.

For the second part note that if p x < w by local non satiation (and continuity of

p x) there exists some x 0 such that x 0 x and p x 0 w .

Thus x 0 is aordable and x % x 0 x as desired.

Example Continued

Consumers choices among 3 goods

w p x

1 300 (10; 10; 10) (10; 10; 10)

2 130 (10; 1; 2) (9; 25; 7:5)

3 110 (1; 1; 10) (15; 5; 9)

Since at prices (10; 10; 10), the bundle (15; 5; 9) costs less than (10; 10; 10):

(10; 10; 10) (15; 5; 9).

Since at prices (10; 1; 2), the bundle (9; 25; 7:5) costs as much as (10; 10; 10):

(9; 25; 7:5) % (10; 10; 10).

Since at prices (1; 1; 10), the bundle (9; 25; 7:5) costs less than (15; 5; 9).

(15; 5; 9) (9; 25; 7:5).

Putting these together:

(10; 10; 10) (15; 5; 9) (9; 25; 7:5) % (10; 10; 10)

These observations are not consistent with utility/preference maximization

theory: they violate transitivity.

Directly Revealed Preference

Denitions

Suppose fx j ; p j ; w j gNj=1 is a nite set of demand data that satisfy p j x j wj.

The directly revealed weak preference is dened by

x j %R x k if p j x k w j

The directly revealed strict preference is dened by

x j R x k if p j x k < w j

if x k was aordable, but the consumer chose x j instead, she revealed that x j is

at least as good a choice as x k .

if x k was strictly aordable, but the consumer chose x j instead, she revealed

that x j is a strictly better choice than x k .

R

is dened directly; it does not necessarily correspond to the asymmetric

component of %R .

Indirectly Revealed Preference

Denitions

Suppose fx j ; p j ; w j gNj=1 is a nite set of demand data that satisfy p j x j wj.

The indirectly revealed weak preference is dened by

x j %R x i 1 ;

if there exists x i1 %R x i2 ;

x % x

j I k

x i1 ; x i2 ; : : : ; x im :::

such that x i m %R x k

The indirectly revealed strict preference is dened by

x j %R x i 1 ;

if there exists x i1 %R x i2 ; and one of the relations

j I k

x x x i1 ; x i2 ; : : : ; x im :::

such that x i m %R x k in the chain is strict

I

is also dened directly from observation, and maybe dierent than the

asymmetric component of %I .

Exercise

Verify that x j %R x k implies x j %I x k .

Verify that if x j %R x k and x k I x i , then x j I

xi .

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