Microeconomics for

Managers

Biresh Sahoo, Ph.D.

Full Professor, XIM, Bhubaneswar

Lecture 4
Utility Function
describing a rational preference relation
A utility function u () represents a preference
relation  if, for every pair of alternatives x, y,
x  y is equivalent to u ( x)  u ( y ).

Two points about u(∙) to be worth noting

1. The u(∙) only preserves the original preference
ordering of the bundles of a consumer.
2. Any strictly increasing function f(∙) applied on u(x),
i.e., v(x) =f(u(x)) also preserves the same original
preference ordering of bundles.
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Desirability
We can also compare the desirability of two
bundles in different ways.

Let us consider two consumption bundles for the

comparison: x  ( x1 ,..., xk ,..., xn ) and y  ( y1 ,..., yk ,..., yn )

Weak Monotonicity.
A preference relation  satisfies weak monotonicity
if, for any alternatives x, y where x  y,
xk  yk for every good k , implies x  y
xk  yk for every good k , implies x  y.
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 Desirability
continued …
Strong Monotonicity.
A preference relation  satisfies strong monotonicity if,
for any alternatives x, y where x  y, and xk  yk for
every good k , we have that x  y.

These two definitions exhibit a connection between

preference relation and the utility function representing
them Weak Monotonicity implies that for  >1
u ( x1 , x2 )  u ( x1 , x2 ) and u ( x1 ,  x2 )  u ( x1 , x2 )

Strong Monotonicity implies that for  >1

u ( x1 , x2 )  u ( x1 , x2 ).
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 Generating Indifference Curve
Good 2 (IC) using strong monotonicity

y x

x
x2*

IC
x y

Good 1
O x1*

Strong monotonicity implies downward slopping IC

 Generating IC using
Good 2 weak monotonicity

y x

x2* IC
x

Good 1
O x1*

Weak monotonicity implies L-shaped IC

 Numerical example: Perfect Complements
u ( x1 , x2 )  min  x1 ,  x2 ;  ,   0

where x1 and x2 represent, respectively, ounces of

coffee and cream.
coffee and cream can be combined in fixed proportion
to yield a complete cup of coffee (perfect complements).

 x1   x2

x2  x1

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 
indicates the rate which goods x1 and x2 must be

Good 2 consumed in order to achieve utility gain


x2  x1



2

u  2


u 



O 1 2 Good 1
 Utility function satisfying
weak monotonicity
u  min  x1 ,  x2 
Increasing both the goods by a common factor yields:

u   min  x1   ,  x2    where u   u.
This utility function satisfies weak monotonicity.

However, increasing only one good, say x1 , yields:

u   min  x1   ,  x2  where u   u.
This utility function is not strongly monotonic.

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 Numerical example: Perfect Substitutes
u ( x1 , x2 )   x1   x2 ;  ,   0
x1 and x2 are substituted at a constant rate to achieve
a given level of satisfaction, i.e., utility (How?)
Let us assign a value to u, i.e., u = uo (say).

uo   x1   x2 Typical examples include goods such as

butter and margarine,
uo 
x2   x1 coffee and black tea, or
  two brands of unflavored
dx2  mineral water.

dx1 
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 Let us assign a value to u, i.e., u = uo (say).

Good 2

The individual is willing to give up units of x2

2uo in order to obtain one more unit of x1 and keep
 his utility level unaffected.

uo IC u  2uo 

IC u  uo 
 
 
O uo 2uo Good 1
 
 Utility function satisfying both
weak and strong monotonicity
u   x1   x2 ;  ,  > 0

Increasing both the goods by a common factor yields:

u   ( x1   )  (  x2   ) where u   u.
This utility function satisfies weak monotonicity.
However, increasing one good alone, say x1 yields

u   ( x1   )   x2 where u   u.
This utility function also satisfies strong monotonicity.

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 Thank you
for your patience

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