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Homothetic vs Non-Homothetic Preferences

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85 views2 pages

Homothetic vs Non-Homothetic Preferences

Helpfulo material for mathematics for economics.

Uploaded by

muhammadattiqueshah786
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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104 Part 2 Choice and Demand

EXAMPLE 3.3 CONTINUED

QUERY: How might you define homothetic functions geometrically? What would the locus
of all points with a particular MRS look like on an individual’s indifference curve map?

EXAMPLE 3.4 Nonhomothetic Preferences

Although all of the indifference curve maps in Figure 3.8 exhibit homothetic preferences, this
need not always be true. Consider the quasi-linear utility function
utility ¼ U ðx, yÞ ¼ x þ ln y. (3.33)
For this function, good y exhibits diminishing marginal utility, but good x does not. The
MRS can be computed as
∂U =∂x 1
MRS ¼ ¼ ¼ y. (3.34)
∂U =∂y 1=y
The MRS diminishes as the chosen quantity of y decreases, but it is independent of the
quantity of x consumed. Because x has a constant marginal utility, a person’s willingness to
give up y to get one more unit of x depends only on how much y he or she has. Contrary to
the homothetic case, then, a doubling of both x and y doubles the MRS rather than leaving
it unchanged.

QUERY: What does the indifference curve map for the utility function in Equation 3.33 look
like? Why might this approximate a situation where y is a specific good and x represents
everything else?

THE MANY-GOOD CASE


All of the concepts we have studied so far for the case of two goods can be generalized to
situations where utility is a function of arbitrarily many goods. In this section, we will briefly
explore those generalizations. Although this examination will not add much to what we have
already shown, considering peoples’ preferences for many goods can be quite important in
applied economics, as we will see in later chapters.

The MRS with many goods


Suppose utility is a function of n goods given by
utility ¼ U ðx1 , x2 , …, xn Þ. (3.35)
The total differential of this expression is
∂U ∂U ∂U
dU ¼ dx1 þ dx2 þ … þ dx (3.36)
∂x1 ∂x2 ∂xn n
and, as before, we can find the MRS between any two goods by setting dU ¼ 0. In this
derivation, we also hold constant quantities of all of the goods other than those two. Hence
we have
Chapter 3 Preferences and Utility 105

∂U ∂U
dU ¼ 0 ¼ dxi þ dx ; (3.37)
∂xi ∂xj j
after some algebraic manipulation, we get
dxj ∂U =∂xi
MRSðxi for xj Þ ¼ ¼ , (3.38)
dxi ∂U =∂xj
which is precisely what we got in Equation 3.17. Whether this concept is as useful as it is in
two dimensions is open to question, however. With only two goods, asking how a person
would trade one for the other is an interesting question—a transaction we might actually
observe. With many goods, however, it seems unlikely that a person would simply trade one
good for another while holding all other goods constant. Rather, it seems more likely that an
event (such as a price increase) that caused a person to want to reduce, say, the quantity of
cornflakes ðxi Þ consumed would also cause him or her to change the quantities consumed of
many other goods such as milk, sugar, Cheerios, spoons, and so forth. As we shall see in
Chapter 6, this entire reallocation process can best be studied by looking at the entire utility
function as represented in Equation 3.35. Still, the notion of making trade-offs between
only two goods will prove useful as a way of conceptualizing the utility maximization process
that we will take up next.

Multigood indifference surfaces


Generalizing the concept of indifference curves to multiple dimensions poses no major mathe-
matical difficulties. We simply define an indifference surface as being the set of points in n
dimensions that satisfy the equation
U ðx1 , x2 , …, xn Þ ¼ k, (3.39)
where k is any preassigned constant. If the utility function is quasi-concave, the set of points
for which U k will be convex; that is, all of the points on a line joining any two points on
the U ¼ k indifference surface will also have U k. It is this property that we will find most
useful in later applications. Unfortunately, however, the mathematical conditions that ensure
quasi-concavity in many dimensions are not especially intuitive (see the Extensions to
Chapter 2), and visualizing many dimensions is virtually impossible. Hence, when intuition
is required, we will usually revert to two-good examples.

SUMMARY
In this chapter we have described the way in which econo- on this map shows all the commodity bundles that yield a
mists formalize individuals’ preferences about the goods they given level of utility.
choose. We drew several conclusions about such preferences
• The negative of the slope of an indifference curve is
that will play a central role in our analysis of the theory of
defined to be the marginal rate of substitution (MRS).
choice in the following chapters:
This shows the rate at which an individual would will-
• If individuals obey certain basic behavioral postulates in ingly give up an amount of one good (y) if he or she were
their preferences among goods, they will be able to rank all compensated by receiving one more unit of another
commodity bundles, and that ranking can be represented good (x).
by a utility function. In making choices, individuals will
• The assumption that the MRS decreases as x is substi-
behave as if they were maximizing this function.
tuted for y in consumption is consistent with the notion
• Utility functions for two goods can be illustrated by an that individuals prefer some balance in their consump-
indifference curve map. Each indifference curve contour tion choices. If the MRS is always decreasing, individuals

Common questions

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The assumption of a utility-maximizing individual using a utility function is related to observable market behavior as it models how individuals make consumption decisions to maximize satisfaction given their budget constraints. This theoretical construct helps explain patterns in consumer choices, such as the law of demand, by positing that consumers choose combinations of goods that bring them the highest utility. These choices manifest as market demand curves and provide a basis for predicting reactions to changes like price shifts.

The quasi-linear utility function U(x, y) = x + ln(y) differs from homothetic preferences as it exhibits non-homothetic preferences. In this function, y shows diminishing marginal utility, whereas x does not. Consequently, the MRS is given by MRS = y, indicating that MRS diminishes only as y decreases, independent of x. In contrast, homothetic preferences imply a constant MRS with proportional changes in goods. Here, doubling x and y doubles the MRS, in contrast to keeping it unchanged, signifying a different utility response.

Visualizing higher-dimensional indifference surfaces presents challenges due to mathematical complexity and the difficulty of imagining more than three dimensions. Economists address these challenges by often reverting to two-dimensional examples to build intuition. In two dimensions, the concept of trade-offs between two goods is easier to grasp, although it simplifies the complexities of real-world decisions, which usually involve multiple goods. The use of quasi-concave properties to ensure convexity helps in some analytical tasks, despite visualization challenges.

The mathematical conditions for ensuring quasi-concavity in utility functions lack intuitive appeal because they often involve complex, higher-dimensional calculus and abstract theoretical constructs. This complexity makes it challenging for intuition-driven understanding, which is essential for practical economic analysis. To address this, economists often employ simpler, lower-dimensional examples to illustrate concepts and support intuition-driven explanations, ensuring the broader implications of quasi-concavity are still understood despite mathematical complexity.

A constant MRS in the context of homothetic preferences implies that as a consumer's income changes, their preference ratio between goods remains unchanged, leading to proportional increases in the consumption of both goods. This aspect of homothetic functions simplifies the analysis of consumer behavior, as it suggests a linear relationship between income changes and consumption choices, making it easier to model and predict how varying budget constraints impact utility maximization.

The primary benefit of representing consumer preferences and utility with indifference curves or surfaces is that they provide a visual and analytical method to depict the combination of goods that yield the same level of utility to the consumer. This representation facilitates understanding of trade-offs and substitution effects between goods and aids in analyzing consumer choices under various constraints and scenarios.

The property of decreasing MRS is aligned with consumer preferences for balanced consumption because it implies that as a consumer substitutes one good (x) for another (y), the rate at which they are willing to make that substitution decreases. This reflects a desire to maintain a certain balance in consumption, avoiding extreme levels of one good over another, which is consistent with typical utility-maximizing behavior where diversity in consumption is generally preferred.

In a multi-good environment, holding all other goods constant while trading one good for another is unlikely because changes in the consumption of one good often affect the consumption of others. For example, a price change in a staple like cornflakes might lead to adjustments in related goods like milk, sugar, and alternatives such as Cheerios. This interrelation complicates single-good trade-offs, making it necessary to consider the entire utility function. Therefore, the multi-good utility maximization involves shifts across several goods rather than isolated substitutions.

The slope of an indifference curve represents the marginal rate of substitution (MRS), which is the rate at which a consumer is willing to exchange one good for another while maintaining the same level of utility. A steeper slope implies a higher willingness to give up a large amount of good y for a small increase in good x, indicating preferences for substitution between goods. Conversely, a flatter slope reflects a lower willingness to substitute one good for another.

Indifference curves can be extended to multiple dimensions by defining an indifference surface, represented by the set of points in n dimensions where U(x1, x2, ..., xn) = k, with k as a constant. The significant mathematical property in this context is quasi-concavity, where if the utility function is quasi-concave, the set of points where U ≥ k will be convex. This means all points on a line joining any two points on this indifference surface will satisfy U ≥ k, a property useful for practical applications but difficult to visualize.

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