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ECO 201 Utility Function Analysis

The document analyzes the monotonicity of various utility functions, concluding that some are monotonic while others are not strictly monotonic. It discusses the relationship between utility functions and preferences, demonstrating that a strictly increasing function preserves preference order. Additionally, it examines the Cobb-Douglas utility function, highlighting diminishing marginal utility and convex preferences.

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8 views2 pages

ECO 201 Utility Function Analysis

The document analyzes the monotonicity of various utility functions, concluding that some are monotonic while others are not strictly monotonic. It discusses the relationship between utility functions and preferences, demonstrating that a strictly increasing function preserves preference order. Additionally, it examines the Cobb-Douglas utility function, highlighting diminishing marginal utility and convex preferences.

Uploaded by

r5y8jcd426
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

ECO 201 Problem Set 1 Solutions

1. We are checking monotonicty of the following utility functions:

(a) u (x1 , x2 ) = 2x1 − 13; monotonic because more of any good is not worse, but not strictly monotonic

because more of good 2 is not strictly better.


 
∂u −2
(b) u (x1 , x2 ) = x1 − (x1)2 ; This one is monotonic, clearly increasing in x1 , and ∂x2 =− (x2 )3
= 2
(x2 )3
> 0,
2

so strictly utility is strictly increasing is both goods.

1 1
(c) u (x1 , x2 ) = 2 ln (x1 ) + 2 ln (x2 ); The ln (x) function is strictly increasing, so u (x1 , x2 ) is monotonic.

(d) u (x1 , x2 ) = ex1 − e−x2 ; Monotonic, the exponential function, ex is strictly increasing, and ∂u
∂x2 =

− (e−x2 (−1)) = e−x2 = 1


ex 2 >0
√
(e) u (x1 , x2 ) = 2x1 + x2 ; Monotonic.

(f) u (x1 , x2 ) = min {x1 , x2 }; Monotonic but not strictly monotonic.


∂u(x1 ,x2 )
M U1 ∂x1 1
2. Here, u (x1 , x2 ) = x1 + x2 . For this utility function, M U2 = ∂u(x1 ,x2 ) = 1 = 1, which is a constant, does not
∂x2

change with x1 or x2 .

3. Suppose u (x) represents the preferences ≿. That means x ≿ y if and only if u (x) ≥ u (y). Now, given the

function f is strictly increasing, the value of f is higher if and only if the input is higher. More precisely,

v (x) ≥ v (y) ⇐⇒ f (u (x)) ≥ f (u (y))

⇐⇒ u (x) ≥ u (y)

⇐⇒ x≿y

So we have x ≿ y if and only if v (x) ≥ v (y). This is the definition of a utility function representing the

preferences, so we can say the function v represents the preferences ≿.

1
4. In this question, v (x1 , x2 ) := f (u (x1 , x2 )), so for the v utility function,

∂v(x1 ,x2 )
M U1 ∂x1
= ∂v(x1 ,x2 )
M U2
∂x2
∂f (u(x1 ,x2 ))
∂x1
= ∂f (u(x1 ,x2 ))
∂x2
′
f (u (x1 , x2 )) ∂u(x1 ,x2 )
∂x1
=
f ′ (u (x1 , x2 )) ∂u(x1 ,x2 )
∂x2
∂u(x1 ,x2 )
∂x1
= ∂u(x1 ,x2 )
∂x2

∂u(x1 ,x2 )
∂x1
But notice that ∂u(x1 ,x2 ) is the MRS for the u utility function. The point here is that although marginal
∂x2

utility for a particular good may change as we take a strictly increasing transformation, the marginal rate of

substitution does not.

√ 1 1
5. Here, we have u (x1 , x2 ) = x1 x2 = (x1 ) 2 (x2 ) 2 , this is the Cobb-Douglas utility function for α = 12 . So here,
  12  1
− 12 1
1 x1 2
M U1 = ∂u
∂x1 = 1
2 (x1 ) (x2 ) 2 = 12 xx21 ≥ 0, and similarly, M U2 = ∂x ∂u
2
= 2 x2 ≥ 0. Also, we can see

that M U1 is decreasing in x1 , and M U2 is decreasing in x2 , and so we have diminishing marginal utility. This

implies that preferences are convex, and they are also monotonic.

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