Mathematics and Statistical Methods

Class 2: Derivatives, Marginal Utility

You should prepare these questions in advance of the class in week 4. You may find
that some of these questions are difficult, and you may need to read further than
simply considering the material covered in lectures. During the class, it is likely that
the class tutor will not have time to cover all of the questions; you should ask the
tutor to discuss questions you find particularly difficult! We will provide solutions
for all questions by the Sunday after classes take place.

1. Consider the utility function 𝑢(𝑐). Suppose that we assume:

𝑢′′(𝑐) > 0

For all possible values of 𝑐. Which of the following must be true?

a) Utility is increasing in 𝑐
b) Utility is positive
c) The marginal utility of consumption is positive
d) The marginal utility of consumption is increasing
e) None of the above

2. Suppose a worker, with utility function 𝑈(𝑥) = √𝑥 , is given the choice

between £A cash or share options which are equally likely to be worth £500
or £2000.

a) Assume both are payable at the same time (i.e. you don’t have to wait
any longer for the shares than the cash – and therefore discounting is
irrelevant here). How large would A need to be for the worker to
choose the cash? Comment.

b) Now assume the share option is payable 2 years from now (t=2),
while the cash is payable now (t=0). (i.e. we now consider individuals
who discount). Assume there are two individuals with the same utility
function as above, but different discount factors (𝛿𝐴 and 𝛿𝐵 ). When
𝐴 = 500 one chooses the cash and the other chooses the share
options. What can we conclude about 𝛿𝐴 and 𝛿𝐵 ?

3. Rosie loves fruits, and her favourite fruit are apples. Her apple consumption
can vary week by week. A friend of Rosie suggests that her enjoyment of
 eating apples can be represented by the following function (where 𝐴
represents the amount of apples and Rosie does sometimes eat fractions of
apples):
𝐴2
𝑢(𝐴) =
ln( 𝐴 + 1)

(a) What is the domain of this function? What is the range? Do these seem
appropriate for the purpose of this function?

(b) Can this function say anything about how much enjoyment Rosie obtains
from exactly zero apples?

(c) Draw a graph of this function. Does it look like a good representation of a
typical economic person’s preferences for apples?

4. It turns out Rosie also enjoys drinking apple cider. Her enjoyment of apple
cider is slightly different from her enjoyment of apples, and is described by
the following function:

𝑢(𝐶) = 10C − 𝐶 2

a) Derive Rosie’s marginal utility (rate of change of the utility function) from
drinking cider. How much cider does Rosie have to drink before she stops
enjoying drinking more cider?

b) Is Rosie’s utility function from drinking cider convex or concave? What does
this mean about Rosie’s marginal utility from drinking cider?

c) List everything that the two functions and results above tell us about Rosie’s
enjoyment of apple and cider. State these observations in non-mathematical
and non-technical terms. These observations should be written as if you are
speaking to a person that has never studied derivatives and does not know
what a utility function is.