Economics 101—Lecture 3

The Basic Model of Consumer Choice I

George J. Mailath

January 20, 2011

 Consumer Preferences

A consumption bundle:

x = (x1 , x2 , x3 , . . . , xn )

where xi is the amount of good i consumed (e.g., books,

pizzas, holidays, fancy dinners, operas, movies).
In many examples, n = 2 (easier to draw pictures), and
then write (x, y ) for a consumption bundle.
If consumer (Bruce) prefers a bundle x to another bundle
x 0 , write x  x 0 .
 “Rational” Choice

Plausible assumptions on behavior:

1 preferences are complete: Bruce can compare any two
bundles, i.e., for all x and x 0 , either x  x 0 , or x 0  x, or
both (i.e., Bruce is indifferent between x and x 0 , written
x v x 0 ). If Bruce strictly prefers x to x 0 (i.e., x  x 0 but not
x 0  x), then write x  x 0 .
2 preferences are transitive: If x  x 0 and x 0  x 00 , then
x x 00 .
 Representing Preferences

Suppose choice set is {x 1 , x 2 , x 2 } and x 1  x 2  x 3 . (For

example, x 1 is Tristan und Isolde at the Metropolitan
Opera, x 2 is a day in the Philadelphia Museum of Art, and
x 3 is Swan Lake.)
If Bruce must choose from {x 1 , x 3 }, he chooses x 1 .
If Bruce must choose from {x 2 , x 3 }, he chooses x 2 .

The utility assignment U (x 1 ) = 3, U (x 2 ) = 2, and U (x 3 ) = 1

represents Bruce’s preferences, in the sense that more
preferred bundles are assigned a higher utility index.
The representing utility function is not unique: V (x 1 ) = 10,
V (x 2 ) = 1, and V (x 3 ) = 0 represents the same preferences;
as does U 2 (i.e., utility is ordinal, not cardinal).
 Comparing Utility

Suppose Bruce and Sheila have the same preferences

over {x 1 , x 2 , x 3 } given by x 1  x 2  x 3 .
Suppose Bruce reports a utility of 3 from the bundle x 1 ,
while Sheila reports a utility of 6. Does this mean Sheila
likes the bundle x 1 twice as much as Bruce?
 Representing Choice

Bruce’s choice of x 1 from {x 1 , x 2 , x 3 } can be represented as

max U (x ),
x ∈{x 1 ,x 2 ,x 3 }

while his choice of x 2 from {x 2 , x 3 } can be represented as

max U (x ).
x ∈{x 2 ,x 3 }
 Consumption bundles of goods

In general, we will consider consumption bundles

x = (x1 , x2 , . . . , xn ) that satisfy

xi ≥ 0, for all i.

Preferences will be represented by a utility function

U (x ) = U (x1 , x2 , . . . , xn ).

Examples:
1 U (x1 , x2 ) = x1 + x2 .
β
2 U (x1 , x2 ) = x1α x2 , where α, β > 0 are constants.
3 U (x1 , x2 ) = x1α + x2 .
 Assumptions on representing U

We will typically (but not always) assume that preferences can

be represented by utility functions with the following properties:

1 U is continuous. If U (x ) > U (x 0 ), then for x̂ sufficiently

close to x and x̂ 0 sufficiently close to x 0 , U (x̂ ) > U (x̂ 0 );
2 U is twice continuously differentiable;
3 U is strictly increasing, i.e.,

∂U
> 0, for all i,
∂xi

(the goods are “good” or “more is preferred to less”; such

preferences are said to be strictly monotone);
4 U is quasiconcave (more on this in a little while).
 Indifference Curves

Suppose consumption bundles are in R2+ .

Indifference curve through x 0 = (x10 , x20 ) is the locus of points x
yielding the same utility, i.e., is the locus of bundles x that the
consumer finds indifferent to x 0 :

U (x1 , x2 ) = U (x 0 ) = u.
ˉ

Implicitly defines a function x2 = f (x1 , uˉ ) by

U (x1 , f (x1 , uˉ )) = u.
ˉ
 Indifference Curves
If U (x ) = x1 + x2 , then f (x1 , uˉ ) = uˉ − x1 .
 Indifference Curves
If U (x ) = x1 x2 , then f (x1 , uˉ ) = u/x
ˉ 1.
 Indifference Curves
If U (x ) = x α + x2 , then f (x1 , uˉ ) = uˉ − x1α .
 Better Than Sets and Quasiconvexity

A set X is convex if for all x ∈ X , x 0 ∈ X , and all λ ∈ (0, 1),

λx + (1 − λ)x 0 ∈ X .

For any bundle x, the set of bundles that the consumer weakly
prefers to x is the weakly better than x set.

The utility function U is quasiconcave if, for all x, the weakly

better than x set is convex.

We say preferences are convex if there is a quasiconcave

representing utility function, or equivalently, if all weakly better
than sets are convex.
 Marginal Rates of Substitution
Slope of an indifference curve: recall indifference curve through
the bundle x 0 with utility uˉ is the function x2 = f (x1 , uˉ ) satisfying

U (x1 , f (x1 , uˉ )) = u.
ˉ

What is the slope of the indifference curve?

Differentiating,
∂U ∂U ∂f
+ = 0,
∂x1 ∂x2 ∂x1
so
∂f ∂U/∂x1 U (x )
=− =− 1 .
∂x1 ∂U/∂x2 U2 (x )
This is the (negative of) the MRS.
Note that 
∂f dx2 
= .
∂x1 dx1 U (x )=uˉ
 Diminishing MRS

A function f (x1 ) is convex if for all x1 , x10 , and all λ ∈ (0, 1),

f (λx1 + (1 − λ)x10 ) ≤ λf (x1 ) + (1 − λ)f (x10 ).

f is convex if f 00 (x1 ) ≥ 0 for all x1 . (This is the opposite of

concave.)

U quasiconcave implies diminishing MRS, i.e., the indifference

curves are convex functions.
 Example: Quasilinear utility
U (x1 , x2 ) = u (x1 ) + x2 , for some increasing u.
dx2 /dx1 = −u 0 and so d 2 x2 /dx12 = −u 00 .
What if u (x1 ) = x1α ?
 Example: perfect complements
U (x1 , x2 ) = min{αx1 , βx2 }, for some α, β > 0.
 Example: Cobb Douglas
β
U (x1 , x2 ) = x1α x2 , for some α, β > 0.
 Example: Perfect substitutes
U (x1 , x2 ) = αx1 + βx2 , for some α, β > 0.