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Goals
Existence of utility function Existence and uniqueness of Marshallian (=empirically observable) demand functions. Constrained Optimization (Lagranges method).
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times
n X Rn + is the consumption set. Note that we assume X R+ because we think of a consumption set as all bundles we are able to think about (e.g. me being F1 driver), rather than something that is achievable.
R+ is the set of all non-negative real numbers; In x, bold implies that it is a vector.
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Source: wikipedia
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Note: Speaking Economics, you should think of x1 x2 as a YES answer to the question Do you weakly prefer x1 to x2 ? and you should think of x1 x2 as a YES answer to the question Do you weakly prefer x1 to x2 ? AND a YES answer to the question Do you weakly prefer x2 to x1 ?. You should not think of x1 x2 as a YES answer to the question Are you indierent between x1 and x2 . If you do, it implies that I introduced two wiggles, and . If so, I need to have axioms both on and on . Axioms are the objects that ll these wiggles with meaning; before I impose axioms, these wiggles are completely meaningless objects. I do not want many axioms. I would rather describe (via axioms) a single wiggle, and then tell you what and means using a single well-dened wiggle.
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Primitives: Axioms on
In English, there are some reqularities in how we answer to the question Do you weakly prefer x1 to x2 ? Before we impose any axioms on , in Mathematics there are no regularities; in fact, before we impose axioms we can write f (x1 , x2 ) and, mathematically, it would make no dierence. Axiom 1, Completeness: For all x1 , x2 , either x1 both. x2 or x2 x1 or x2
Axiom 2, Transitivity: For any three bundles x1 , x2 , and x3 , if x1 and x2 x3 , then x1 x3 . For an abstract binary relation , if completeness and transitivity is satised, we will call the binary relation preferences.
Note: what we done here is that we came a step closer matching our mathematical notation, , to what me mean in English when we say preferences.
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Completeness: what do you like better, a live chicken or a boiled egg? Failure of transitivity: (redwine , cheese ) (whitewine , cheese ); (beer , cheese ) (redwine , cheese ), (whitewine , cheese ) (beer , cheese ).
Note that (redwine , meat ) (whitewine , meat ); (beer , crackers ) (redwine , crackers ), (whitewine , cheese ) not violate transitivity. (beer , cheese ) does
However, there is a major problem with an individual who violates transitivity in a consistent way (not as a mistake)
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x1 x2 , x2 x3 , x3 x1 Start with x3 ; a penny for x2 ; a penny for x1 ; a penny for x3 . The same bundle, but three pennies less. Repeat innitely.
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A note on Sneetches
Preferences of individual P (initially a plain-belly sneetch): same belly as individual 2. Preferences of individual S (initially a star-belly sneetch): belly that is dierent from individual 1. Formal model: X = {0, 1} {0, 1} (The rst number refers to whether a plain-belly-type of
sneetch has a star (1) or not (0) and the second number refers to whether a star-belly sneetch has a star (1) or not (0). The consumption bundle (1, 1) means that both sneetches have stars.) (1, 1) P (0, 1) and (0, 0) P (1, 0) These are preferences of a plain-belly sneetch. This is indicated by superscript P . Note that these preferences are
not completely specied; other combinations of 0 and 1 are possible. (1, 0) S (1, 1) and (0, 1) S (1, 1) There is no violation of transitivity. Note that we do not compare plain-belly
and star-belly sneetches. They are two dierent individuals and we check the violation of transitivity separately for each of them. Further details on the story: Dr. Seuss, Sneetches
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Axioms 3 and 4, I
Axioms 3 and 4 are more technical axioms. If they are violated, some results can still be recovered. Hence, we do not discuss them. Axiom 3, Continuity: there are no sudden changes in preferences, such that 1 orange is better than 0.99999 apple, but 1 apple is better than 1 orange. Mathematically: consider a sequence of pieces of apples, 0.9; 0.99; 0.999; 0.9999. Suppose that each element of this sequence is weakly worse than an orange. This sequence converges to a whole apple. Continuity would then imply that an apple is weakly worse than an orange.
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Axioms 3 and 4, II
Mathematically: consider a sequence of pieces of apples, 0.9; 0.99; 0.999; 0.9999. Suppose that each element of this sequence is weakly worse than an orange. This sequence converges to a whole apple. Continuity would then imply that an apple is weakly worse than an orange.
Formally: Consider a sequence yn X such that x yn and yn y. Then x y. Consider a sequence zn X such that zn x and zn z. Then z y. Alternative denition (as in JR): for any x X , the sets (x) = {y X |x y} (lower contour set) and (x) = {z X |z (upper contour set) are closed. x}
If it is not obvious to you that these two denitions are equivalent, please have a look at the denition of a closed set and convince yourself that this is true. We will use open/closed sets later, so it would be useful to be familiar with the concepts. Notation: {a A|B} means all a from A such that B is true.
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x1 ,
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Note. Suppose u (x) = x1 + x2 represents preference relation . Let us 2 + 2x x + x 2 . Utility function v must represent the look at v (x) = x1 1 2 same preference relation because 2 + 2x x + x 2 = (x + x )2 x1 1 2 1 2 For any two bundles x 0 , x 1 , whenever u (x 0 ) > u (x 1 ), we know that 2 2 v (x 0 ) = u (x 0 ) > u (x 1 ) = v (x 1 ) For any increasing function f : R R, u (x) and f (u (x)) represent the same preference relation (more details: Theorem 1.2 in JR).
How to make a person twice as happy does not make sense. How much of good 2 is needed to compensate for the loss of one unit of good 1 makes sense. f : A B : f takes an element from A and maps it to an element in B , f (a) = b .
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Why is it not obvious? Consider lexicographic preferences: for any two 0 bundles x0 , x1 R2 x1 if +, x 0 > x 1 or x1 1 0 = x 1 , then x 0 > x 1 if x1 1 2 2 How would you measure bundle (1, 3) in terms of the bundle (1, 1)? We know that (1, 3) (1, 1), but if we improve (1, 1) a bit, e.g. (1.001, 1.001), suddenly (1.001, 1.001) (1, 3) (example hints at the importance of continuity).
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Theorem (Theorem 1.1, JR) If preference relation is continuous and strictly monotonic, there exists a continuous function u : X R, which represents . Proof: For each x, dene u (x) R (note, this is just a number) as a number such that u (x)e x. Is u (x) well dened? That is, does it exist for any x and is it unique (if not, we would need to specify a selection rule to pick a particular number)
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Consider two sets, A = {t |t e x} and B = {t |x t e}. Note that both are the sets in R. We would intuitively think that one such set is [, ) and another is [0, ] and would be exactly u (x). We need to show it using axioms. Observation 1: if we can show that there is t such that t A B , then t would dene u (x). We show that such t exists in three steps:
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Note that strict monotonicity implies that if t e x, and > t , it must be that e x. Also, if x t e and < t , it must be that x e. From step 1, it follows that set A must be of the form (t , ) or [t , ), where t is an arbitrary number. From continuity, the set A must be closed, so it is [t , ) (I am sloppy here, because the sets A and (x) are not the same and we assumed that (x) is closed, not A). Set B is [0, t ]. Suppose t < t ; that is, there is t such that it is not in A or in B . From completeness, it must be the case that either (i) t e x or (ii) x t e. Yet, if (i) holds, t must belong to A and if (ii) holds, it must belong to B . Thus, we conclude that t t t t As t t t t , t (as well as t ) belongs to both A and B . The number t denes u (x).
In summary: for every x we have found a way to associate a number. Note, that we still have to show that these numbers represent preferences . Before we turn to that, we need to show that if we pick t , we would not get a dierent number.
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Suppose that there are two numbers, t and t such that t e x t e. By transitivity, t e t e. By strict monotonicity, t = t (Note how it would not
be true if, at some point, an individual would not have wanted any more goods)
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Consider two bundles, x1 and x2 . We have devised a way to construct a number for each of these bundles, u (x1 ) and u (x2 ). Can we be sure that x1 x2 if and only if (denoted by ) u (x1 ) > u (x2 ). By construction: u (x1 )e x1 x2 u (x2 )e. By transitivity, u (x1 )e u (x2 )e. By strict monotonicity, u (x1 ) u (x2 ). Hence, if x1 x2 , u (x1 ) u (x2 ). To show the reverse direction, we repeat the steps in reverse order. We skip continuity argument.
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is a preference relation.
1
Completeness: for any two bundles, we have specied a procedure how to compare them Transitivity: Suppose there are three bundles, x1 , x2 , x3 such that x1 x2 and x2 x3 . We need to show that x1 x3 . 1 2 1 2 1 2 If x1 x2 , it means that either x1 x1 and, if x1 = x1 , x2 x2 . 2 3 2 3 2 3 2 3 If x x , it means that either x1 x1 and, if x1 = x1 , x2 x2 . Combining these two observations, we see that it must be the case that 1 3 1 3 1 3 x1 x1 and, if x1 = x1 , then x2 x2 . That means that x1 x3 .
In step 2 on page 16 we use continuity to show that set A is [t , ). For point (1, 4), this set is, actually, (1, ) because (1, 4) e, but for any > 1, e (1, 4). Note that if we do not require that u maps into R, but, instead, require it to map into R2 , then the function is already given, which is these numbers themselves. That is, x = (x1 , x2 ) X maps into u (x) = (x1 , x2 ) R2 .
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