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9/12/2011

Quasilinear Preferences

Quasilinear utility functions are not particularly realistic…” (Varian, pg. 63)

In response to the very good request for examples of quasilinear utility and my subsequent stumbling over trying to think of a good example on the fly, here is what I hope is a better explanation of quasilinear preferences and an example in which they might arise.

Suppose a consumer has a utility function that is linear in one of the goods , but is (possibly) nonlinear in another good . The utility function can takes the form:

where is some function of . This utility function has the special characteristic that it is convex, additively separate, and each indifference curve is a vertically shifted version of a single indifference curve. Additively separate implies that the utility derived from can be distinguished uniquely or separately from the utility derived from .

In microeconomics, you will typically encounter quasilinear preferences which take one of

two forms:

or

. It is useful to know how to solve both.

Graphically, these typically will have a shape that resembles:

Please note that these indifference curves illustrate two different sets of preferences (hence they can cross). The natural logarithmic quasilinear utility function tends to decrease much more rapidly compared to the square-root quasilinear utility function for smallvalues of .

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EXAMPLE:

9/12/2011

The typical example of quasilinear utility that youll often find is a consumer that gets utility from the consumption of some good, such as apples ( ), and utility from consumption of all other goods

( ). You can think of as reflecting the money spent on all other goods. These examples are

particularly useful when the good of interest is not a large component of the consumers budget.

Suppose Ragvir is walking in central London and realizes he skipped breakfast and is hungry, but hes a poor student and only has one British pound (£) in his pocket. He passes a fruit stand and a Pink Lady apple is too delicious to pass up. Ragvir decides to buy an apple for a pound and he doesnt have any money for anymore purchases.

Now suppose Ragvir just received a check from his parents and he now has £100 in his pocket. He still has skipped breakfast so he wants to buy an apple, but now hell have £99.00 to spend on all other goods. Ragvirs income has increased 100 fold, such that the total amount that he can consume has increased, but he has not increased his consumption of apples compared to the case when his income was very low.

Now suppose Ragvir wins the lottery and receives a £100 million check, which he cashes and carries around in a briefcase. He still has a tendency to skip breakfast and he still finds a Pink Lady too delicious to pass up during his morning commute. Even though Ragvir could buy any amount of apples that his heart desired, his preferences are such that he does not choose bundles in which he consumes more than a single apple.

Ragvirs indifference curve map might look something like this:

All Other

Goods

U
3
U
2
U
1
1
Apples

Ragvir is unwilling to give up very much consumption of all other outside goods after he has consumed one apple. Additionally, as Ragvir is apple to consume more of all goods (i.e. as his indifference curves increase), he has no preferences to increase his apple consumption.

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