Utility Functions

What is a useful way of creating a ranking? If we had only ten consumption bundles to
worry about then all we would have to do is create a list, from most preferred to least preferred
(allowing for ties) and our ranking would be set. Expand this notion to hundreds and then
thousands and even millions of bundles and the idea of a 'list' becomes very unappealing.
Moreover, the real problem is that the number of possible consumption bundles is actually
infinite, so creating an infinite list is also impossible. This brings us back to our question of
whether there is there a more useful way of creating a ranking. The way economists have found
around this problem is to assign basket numbers in a way that is consistent with one's
preferences. So, for example, if 10 apples and 2 loaves of bread make Celeste indifferent to 3
apples and 7 loaves of bread then she would assign both these baskets the same number,
indicating that she is indifferent between the two. If she prefers both these baskets over a third
basket, say 5 apples and 3 loaves of bread, then the number assigned to the third basket
should be lower. That way, in order to understand Celeste’s preferences when comparing any
number of bundles all we have to do is check their assigned number and we would know which
one is the most preferred. This process of assigning numbers to baskets fits the very definition
of a function.1 And because this function provides us a useful way of keeping track of a person's
ranking of bundles, economists refer to it as the utility function. The notation for this function is
as follows:
U(q₁,q₂) ,

where q₁ represents the amount of the first good that the bundle has, q₂ the amount of the
second good that the bundle has and U is the name of the utility function.
We can think of an individual's utility function as the key to unlocking that person's
preferences over consumption bundles. If we knew nothing about a person except for the fact
that this person's preferences over consumption bundles is given by the following utility function:

U(q₁,q₂) = q₁ × q₂,

then we would know everything we need to know in terms of the person's ranking of
consumption bundles. For example, in Figure 2A.1 we can see how this person is indifferent
between bundles (2,8) and (4,4) because U(2,8)=2×8=16 and U(4,1)=4×4=16, both these
bundles are preferred to (6,2) because U(1,6)=6×2=12 and (3,6) is preferred to all the other
three because U(3,6)= 3×6=18.

1
The domain is the set of all bundles and the range is the set of all real numbers. See the
math review video for a refresher.
Figure 2A.1

And we can perform these comparisons for any consumption bundles we want, because the
utility function allows for any q₁ and q₂ to be used. For example, Figure 2A.2 shows the utility
levels of 10 different bundles, and we could continue adding as many as we want to the graph
because for any bundle we can think of there will always be a utility level that corresponds to it.
Figure 2A.2