Chapter Four Utility.

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Presentation transcript:

Chapter Four Utility

Utility Functions & Indiff. Curves Consider the bundles (4,1), (2,3) and (2,2). Suppose (2,3) (4,1) ~ (2,2). Assign to these bundles any numbers that preserve the preference ordering; e.g. U(2,3) = 6 > U(4,1) = U(2,2) = 4. Call these numbers utility levels. p

Utility Functions & Indiff. Curves An indifference curve contains equally preferred bundles. Equal preference  same utility level. Therefore, all bundles in an indifference curve have the same utility level.

Utility Functions & Indiff. Curves So the bundles (4,1) and (2,2) are in the indiff. curve with utility level U º 4 But the bundle (2,3) is in the indiff. curve with utility level U º 6. On an indifference curve diagram, this preference information looks as follows:

Utility Functions & Indiff. Curves x2 (2,3) (2,2) ~ (4,1) p U º 6 U º 4 x1

Utility Functions & Indiff. Curves Another way to visualize this same information is to plot the utility level on a vertical axis.

Utility Functions & Indiff. Curves 3D plot of consumption & utility levels for 3 bundles Utility U(2,3) = 6 U(2,2) = 4 U(4,1) = 4 x2 x1

Utility Functions & Indiff. Curves This 3D visualization of preferences can be made more informative by adding into it the two indifference curves.

Utility Functions & Indiff. Curves x2 Higher indifference curves contain more preferred bundles. x1

Utility Functions & Indiff. Curves Comparing more bundles will create a larger collection of all indifference curves and a better description of the consumer’s preferences.

Utility Functions & Indiff. Curves x2 U º 6 U º 4 U º 2 x1

Utility Functions & Indiff. Curves As before, this can be visualized in 3D by plotting each indifference curve at the height of its utility index.

Utility Functions & Indiff. Curves x2 U º 3 U º 2 U º 1 x1

Utility Functions & Indiff. Curves Comparing all possible consumption bundles gives the complete collection of the consumer’s indifference curves, each with its assigned utility level. This complete collection of indifference curves completely represents the consumer’s preferences.

Utility Functions & Indiff. Curves x2 x1

Utility Functions & Indiff. Curves x2 x1

Utility Functions & Indiff. Curves x2 x1

Utility Functions & Indiff. Curves x2 x1

Utility Functions & Indiff. Curves x2 x1

Utility Functions & Indiff. Curves x2 x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1

Utility Functions & Indiff. Curves x1