GARP and Afriat's Theorem

GARP and Afriat’s Theorem
Production
Econ 2100 Fall 2018
Lecture 8, September 24
Outline
1 Generalized Axiom of Revealed Preferences
2 Afriat’s Theorem
3 Production Sets and Production Functions
4 Pro…ts Maximization, Supply Correspondence, and Pro…t Function
5 Hotelling and Shephard Lemmas
6 Cost Minimization
From Last Class
fx j ; p j ; w j gNj=1 is a …nite set of demand data that satisfy p j x j wj.

Directly revealed weak preference: x j %R x k if pj x k wj
Directly revealed strict preference: x j R
xk if p j x k < w j
Indirectly revealed weak preference:
x j %I x k if 9 x i1 ; : : : ; x im s.t. x j %R x i1 ; :::; x im %R x k
Indirectly revealed strict preference:
xj I
x k if 9 x i1 ; : : : ; x im s.t. x j %R x i1 ; :::; x im %R x k with one strict
Using these de…nitions, we can …nd a condition that guarantees choices are the
result of the maximizing a preference relation or a utility function.
Generalized Axiom of Revealed Preference
Axiom (Generalized Axiom of Revealed Preference - GARP)
If x j %R x k , then not x k I
xj .
xj .
If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

be indirectly revealed strictly preferred to that choice.
xj .

Note that if p j x j < w j then x j R x j and therefore x j I x j and therefore
GARP cannot hold.
xj .

GARP cannot hold.
Therefore, GARP implies the consumer spends all her money.
xj .

GARP cannot hold.
Now suppose x j %R x k and x k I x j . Then there is a chain of weak preference
from j to k, and a chain back (from k to j) that has at least one strict
preference.
xj .

GARP cannot hold.
preference.
This is a cycle with a strict preference inside; if such a cycle exists one can
construct a “money pump” to make money o¤ the consumer and leave her
exactly at the bundle she started from.
xj .

GARP cannot hold.
preference.
GARP rules these cycles out.
xj .

GARP cannot hold.
preference.
GARP rules these cycles out.
Problem 4, Problem Set 4.

Show that GARP is equivalent to the following: If x j %I x k then not x k I
xj .
Utility and Demand Data
De…nition
A utility function u : Rn+ ! R rationalizes a …nite set of demand data
fx j ; p j ; w j gNj=1 if
u(x j ) u(x) whenever pj x wj
De…nition
This de…nition can alternatively be stated by the condition

x j 2 arg maxn u(x) subject to p j x wj
x 2R+
De…nition
This de…nition can alternatively be stated by the condition

x j 2 arg maxn u(x) subject to p j x wj
x 2R+
If the observations satisfy the de…nition, the data is consistent with the
behavior of an individual who, in each observation, chooses a
utility-maximizing bundle subject to the corresponding budget constraint.
Afriat’s Theorem
Theorem (Afriat)
Given a …nite set of demand data f(x j ; p j ; w j )gNk=1 , the following are equivalent:
Afriat’s Theorem
Theorem (Afriat)
1 There exists a locally nonsatiated utility function which rationalizes the data.
Afriat’s Theorem
Theorem (Afriat)
2 The data satisfy the Generalized Axiom of Revealed Preference.
Afriat’s Theorem
Theorem (Afriat)
j
3 There exist numbers v j ; > 0 such that
k j j
v v + [p j x k w j ]; for all j; k = 1; : : : ; N (G)
Afriat’s Theorem
Theorem (Afriat)
j
k j j
4 There exists a continuous, strictly increasing, and concave utility function
which rationalizes the data.
Afriat’s Theorem
Theorem (Afriat)
j
k j j
Under GARP, the consumer behaved as if each choice was optimal (i.e.
utility-maximizing).
Afriat’s Theorem
Theorem (Afriat)
j
k j j
Under GARP, the consumer behaved as if each choice was optimal (i.e.
utility-maximizing).
The fact (4) implies (1) is immediate (strictly increasing implies locally non
satiated). We will skip the remainder of the proof, but see Kreps or Varian for
it.
Afriat’s Theorem
Theorem (Afriat)
3 There exist numbers v j ; j > 0 such that
j
vk vj + [p j x k w j ]; for all j; k = 1; : : : ; N (G)
Afriat’s Theorem
Theorem (Afriat)
j
For …nite data, the only implication of preference maximization is GARP;

conversely, if the data violate GARP, the consumer is not maximizing any
continuous, strictly monotone, and convex preference relation.
Afriat’s Theorem
Theorem (Afriat)
j

Using a …nite number of observations, one cannot distinguish a continuous,
strictly monotone, and convex preference from a locally nonsatiated one.
Afriat’s Theorem
Theorem (Afriat)
j

One way to test if demand data falsify utility maximization is to see if one can
…nd the numbers in (G).
Afriat’s Theorem
Theorem (Afriat)
j

One way to test if demand data falsify utility maximization is to see if one can
…nd the numbers in (G).
These numbers help us construct a function that rationalizes data: each
observation has “utils” v i and a “budget violating penalty/prize” i ; every
choice is rational given these.
The Afriat Numbers
j j
9v j ; > 0 s.t. v k vj + [p j x k w j ] for all j; k = 1; : : : ; N (G)
k
One uses the numbers v k and to construct a function that rationalizes the
data;
the theorem then says that every choice is rational.
Where are the Afriat’s numbers coming from?

The Afriat Numbers
j j
k
data;

Consider utility maximization subject to a budget constraint:
x 2 arg maxn u(x) s.t. p x w:
x 2R+
The Afriat Numbers
j j
k
data;

x 2R+
The solution maximizes the Lagrangean:

L(x; ) = u(x) + (w p x):
The Afriat Numbers
j j
k
data;

x 2R+

L(x; ) = u(x) + (w p x):
Let x and be the optimal consumption and multiplier values, respectively.
The Afriat Numbers
j j
k
data;

x 2R+

L(x; ) = u(x) + (w p x):
Then we have L(x ; ) L(x ; ) for all x 2 Rn+ . That is,
u(x ) + (w p x ) u(x ) + (w p x ):
| {z }
=0 since budget constraint binds
The Afriat Numbers
j j
k
data;

x 2R+

L(x; ) = u(x) + (w p x):
Then we have L(x ; ) L(x ; ) for all x 2 Rn+ . That is,
u(x ) + (w p x ) u(x ) + (w p x ):
| {z }
=0 since budget constraint binds
Thus for all x 2 Rn+
u(x ) u(x ) + (p x w)
Intuition Behind the Afriat Numbers
j j
Another intuition behind Afriat’s numbers

Rewrite (G) as
j j
vk vj [p x k w j ]:
Suppose that p j x k w j > 0. Then x k was una¤ordable at p j and w j .
Even if x k yields more “utils” than x j , at p j and w j the penalty for violating the
budget constraint (given by j [p j x k w j ]) is too large for the change in the
value of the choice (given by v k v j ) to compensate for it.
Thus, the decision maker chose x j over all other alternatives at p j and w j .
Suppose that p j x k wj 0. Then x k was a¤ordable at p j and w j .
But then (G) implies that
vj vk j
[w j p j x k ]:
j k
So the decision maker chose x over x because the di¤erence in “utils” is
higher than the bonus from having some extra money left over by choosing x k
instead of x j .
Producers and Production Sets
Producers are pro…t maximizing …rms that buy inputs and use them to produce and
then sell outputs.
The plural is important because most …rms produce more than one good.
then sell outputs.
The standard undergraduate textbook description focuses on one ouput and a

few inputs (two in most cases).
then sell outputs.

In that framework, production is described by a function that takes inputs as
the domain and output(s) as the range.
then sell outputs.

Here we focus on a more general and abstract version of production.
then sell outputs.

De…nition
A production set is a subset Y Rn .
then sell outputs.

De…nition
y = (y1 ; :::; yN ) denotes production (input-output) vectors.

then sell outputs.

De…nition

A production vector has outputs as non-negative numbers and inputs as
non-positive numbers: yi 0 when i is an input, and yi 0 if i is an output.
then sell outputs.

De…nition

A production vector has outputs as non-negative numbers and inputs as
non-positive numbers: yi 0 when i is an input, and yi 0 if i is an output.
What is p y in this notation?
Production Set Properties
De…nition
Y Rn satis…es:
Draw Pictures.
De…nition
Y Rn satis…es:
no free lunch if Y \ Rn+ f0n g;
Draw Pictures.
De…nition
Y Rn satis…es:
possibility of inaction if 0n 2 Y ;
Draw Pictures.
De…nition
Y Rn satis…es:
free disposal if y 2 Y implies y 0 2 Y for all y 0 y;
Draw Pictures.
De…nition
Y Rn satis…es:
irreversibility if y 2 Y and y 6= 0n imply y2
= Y;
Draw Pictures.
De…nition
Y Rn satis…es:
= Y;
nonincreasing returns to scale if y 2 Y implies y 2 Y for all 2 [0; 1];
Draw Pictures.
De…nition
Y Rn satis…es:
= Y;
nondecreasing returns to scale if y 2 Y implies y 2 Y for all 1;
Draw Pictures.
De…nition
Y Rn satis…es:
= Y;
constant returns to scale if y 2 Y implies y 2 Y for all 0;
Draw Pictures.
De…nition
Y Rn satis…es:
= Y;
0 0
additivity if y ; y 2 Y imply y + y 2 Y ;
Draw Pictures.
De…nition
Y Rn satis…es:
= Y;
0 0
convexity if Y is convex;
Draw Pictures.
De…nition
Y Rn satis…es:
= Y;
0 0
convexity if Y is convex;
Y is a convex cone if for any y ; y 0 2 Y and ; 0, y + y 0 2 Y .
Draw Pictures.
Production Set Properties Are Related
Some of these properties are related to each other.
Exercise
Y satis…es additivity and nonincreasing returns if and only if it is a convex cone.
Production Set Properties Are Related
Some of these properties are related to each other.
Exercise
Y satis…es additivity and nonincreasing returns if and only if it is a convex cone.
Exercise
For any convex Y Rn such that 0n 2 Y , there is a convex Y 0 Rn+1 that
satis…es constant returns such that Y = fy 2 Rn : (y ; 1) 2 Rn+1 g.
Production Functions
Let y 2 Rm n
+ denote outputs while x 2 R+ represent inputs; if the two are related by
n m
a function f : R+ ! R+ , we write y = f (x) to say that y units of outputs are
produced using x amount of the inputs.
Let y 2 Rm n
n m
When m = 1, this is the familiar one output many inputs production function.
Let y 2 Rm n
n m
Production sets and the familiar production function are related.
Let y 2 Rm n
n m
Production sets and the familiar production function are related.
Exercise
Suppose the …rm’s production set is generated by a production function
f : Rn+ ! Rm n
+ , where R+ represents its n inputs and R+ represents its m outputs.
Let
Y = f( x; y ) 2 Rn Rm
+ :y f (x)g:
Prove the following:
1 Y satis…es no free lunch, possibility of inaction, free disposal, and irreversibility.
2 Suppose m = 1. Y satis…es constant returns to scale if and only if f is
homogeneous of degree one, i.e. f ( x) = f (x) for all 0.
3 Suppose m = 1. Y satis…es convexity if and only if f is concave.
Transformation Function
We can describe production sets using a function.
De…nition
Given a production set Y Rn , the transformation function F : Y ! R is de…ned
by
Y = fy 2 Y : F (y ) 0 and F (y ) = 0 if and only if y is on the boundary of Y g ;
the transformation frontier is
fy 2 Rn : F (y ) = 0g
De…nition
by
fy 2 Rn : F (y ) = 0g
De…nition
Given a di¤erentiable transformation function F and a point on its transformation
frontier y , the marginal rate of transformation for goods i and j is given by
@F (y )
@yi
MRTi ;j = @F (y )
@yj
De…nition
by
fy 2 Rn : F (y ) = 0g
De…nition
@F (y )
@yi
MRTi ;j = @F (y )
@yj
Since F (y ) = 0 we have
@F (y ) @F (y )
dyi + dyj = 0
@yi @yj
De…nition
by
fy 2 Rn : F (y ) = 0g
De…nition
@F (y )
@yi
MRTi ;j = @F (y )
@yj
Since F (y ) = 0 we have
@F (y ) @F (y )
dyi + dyj = 0
@yi @yj
MRT is the slope of the transformation frontier at y .
Pro…t Maximization
Pro…t Maximizing Assumption

The …rm’s objective is to choose a production vector on the trasformation frontier
as to maximize pro…ts given prices p 2 Rn++ :
max p y
y 2Y
or equivalently
max p y subject to F (y ) 0

max p y
y 2Y
or equivalently
Does this distinguish between revenues and costs? How?


max p y
y 2Y
or equivalently

Using the single output production function:
max pf (x) w x
x 0

max p y
y 2Y
or equivalently

Using the single output production function:
max pf (x) w x
x 0
here p 2 R++ is the price of output and w 2 Rl++ is the price of inputs.
First Order Conditions For Pro…t Maximization
max p y subject to F (y ) = 0
Pro…t Maximizing
Pro…t Maximizing
The FOC are
@F (y )
pi = for each i or p = rF (y ) in matrix form
@yi |{z} | {z }
1 n 1 n
Pro…t Maximizing
The FOC are
@F (y )
@yi |{z} | {z }
1 n 1 n
Therefore
@F (y )
1 @yi
= for each i
pi
Pro…t Maximizing
The FOC are
@F (y )
@yi |{z} | {z }
1 n 1 n
Therefore
@F (y )
1 @yi
= for each i
pi
the marginal product per dollar spent or received is equal across all goods.
Pro…t Maximizing
The FOC are
@F (y )
@yi |{z} | {z }
1 n 1 n
Therefore
@F (y )
1 @yi
= for each i
pi
Using this formula for i and j:
@F (y )
@yi pi
@F (y )
= MRTi ;j = for each i; j
pj
@yj
Pro…t Maximizing
The FOC are
@F (y )
@yi |{z} | {z }
1 n 1 n
Therefore
@F (y )
1 @yi
= for each i
pi
Using this formula for i and j:
@F (y )
@yi pi
@F (y )
= MRTi ;j = for each i; j
pj
@yj
the Marginal Rate of Transformation equals the price ratio.

Supply Correspondence and Pro…t Functions
De…nition
Given a production set Y Rn , the supply correspondence y : Rn++ ! Rn is:
y (p) = arg max p y :
y 2Y
De…nition
y 2Y
Tracks the optimal choice as prices change (similar to Walrasian demand).

De…nition
y 2Y
De…nition
Given a production set Y Rn , the pro…t function : Rn++ ! R is:
(p) = max p y :
y 2Y
De…nition
y 2Y
De…nition
(p) = max p y :
y 2Y
Tracks maximized pro…ts as prices change (similar to indirect utility function).

De…nition
y 2Y
De…nition
(p) = max p y :
y 2Y
Tracks maximized pro…ts as prices change (similar to indirect utility function).
Proposition
If Y satis…es non decreasing returns to scale either (p) 0 or (p) = +1.
Proof.
Question 6, Problem Set 5.
Properties of Supply and Pro…t Functions
Proposition
Suppose Y is closed and satis…es free disposal. Then:
Proposition
( p) = (p) for all > 0;
Proposition
( p) = (p) for all > 0;
is convex in p;
Proposition
( p) = (p) for all > 0;
is convex in p;
y ( p) = y (p) for all > 0;
Proposition
( p) = (p) for all > 0;
is convex in p;
y ( p) = y (p) for all > 0;
if Y is convex, then y (p) is convex;
Proposition
( p) = (p) for all > 0;
is convex in p;
y ( p) = y (p) for all > 0;
if jy (p)j = 1, then is di¤erentiable at p and r (p) = y (p) (Hotelling’s
Lemma).
Proposition
( p) = (p) for all > 0;
is convex in p;
y ( p) = y (p) for all > 0;
if jy (p)j = 1, then is di¤erentiable at p and r (p) = y (p) (Hotelling’s
Lemma).
if y (p) is di¤erentiable at p, then Dy (p) = D 2 (p) is symmetric and
positive semide…nite with Dy (p)p = 0.
The Pro…t Function Is Convex
Proof.
Let p,p 0 2 Rn++ and let the corresponding pro…t maximizing solutions be y and y 0 .
Proof.
For any 2 (0; 1) let p = p + (1 ) p 0 and let y be the pro…t maximizing
output vector when prices are p.
Proof.
By “revealed preferences”
p y p y and p0 y 0 p0 y
Proof.
why?
Proof.
why?
multiply these inequalities by and 1
p y p y and (1 ) p0 y 0 (1 ) p0 y
Proof.
why?
p y p y and (1 ) p0 y 0 (1 ) p0 y
summing up
p y + (1 ) p0 y 0 [ p + (1 ) p0] y
Proof.
why?
p y p y and (1 ) p0 y 0 (1 ) p0 y
summing up
p y + (1 ) p0 y 0 [ p + (1 ) p0] y
using the de…nition of pro…t function:
(p) + (1 ) (p 0 ) ( p + (1 ) p0)
proving convexity of (p).
The Supply Correspondence Is Convex
Proof.
Let p 2 Rn++ and let y ; y 0 2 y (p).
Proof.
We need to show that if Y is convex then
y + (1 ) y 0 2 y (p) for any 2 (0; 1)
Proof.
y + (1 ) y 0 2 y (p) for any 2 (0; 1)
By de…nition:
p y p y for any y 2 Y
Proof.
y + (1 ) y 0 2 y (p) for any 2 (0; 1)
By de…nition:
p y p y for any y 2 Y and p y0 p y for any y 2 Y
Proof.
y + (1 ) y 0 2 y (p) for any 2 (0; 1)
By de…nition:
multiplying by and 1 we get

p y p y and (1 ) p y0 (1 )p y
Proof.
y + (1 ) y 0 2 y (p) for any 2 (0; 1)
By de…nition:

p y p y and (1 ) p y0 (1 )p y
Therefore, summing up, we have
p y + (1 ) p y0 [ + (1 )] p y
Proof.
y + (1 ) y 0 2 y (p) for any 2 (0; 1)
By de…nition:

p y p y and (1 ) p y0 (1 )p y
Therefore, summing up, we have
p y + (1 ) p y0 [ + (1 )] p y
Rearranging:
p [ y + (1 ) y 0] p y
proving convexity of y (p).
Hotelling’s Lemma
if jy (p)j = 1, then is di¤erentiable at p and r (p) = y (p)
Proof.
Suppose y (p) is the unique solution to max p y subject to F (y ) = 0.
Hotelling’s Lemma
Proof.
The Envelope Theorem says
>
Dq (x (q); q) = Dq (x; q)jx =x (q);q=q [ (q)] Dq F (x; q)jx =x (q);q=q
Hotelling’s Lemma
Proof.
>
In our setting,
Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
F (x ; q) = F (y ), and
Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
F (x ; q) = F (y ), and
(x (q); q) = (p).
Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
F (x ; q) = F (y ), and
(x (q); q) = (p).
Thus, by the envelope theorem:
>
r (p) = Dp (p y )jy =y (p) [ (p)] Dp F (y )jy =y (p)
Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
F (x ; q) = F (y ), and
(x (q); q) = (p).
> >
r (p) = Dp (p y )jy =y (p) [ (p)] Dp F (y )jy =y (p) = y jy =y (p) [ (p)] 0
Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
F (x ; q) = F (y ), and
(x (q); q) = (p).
> >
because p y is linear in p and Dp F (y ) = 0.

Hotelling’s Lemma
Proof.
>
In our setting,
(x ; q) = p y ,
F (x ; q) = F (y ), and
(x (q); q) = (p).
> >
because p y is linear in p and Dp F (y ) = 0.

Therefore
r (p) = y (p)
as desired.
Law of Supply
Remark
If y (p) is di¤erentiable at p, then Dy (p) = D 2 (p) is positive semide…nite.
Write the Lagrangian

L=p y F (y )
Law of Supply
Remark

L=p y F (y )
By the Envelope Theorem:
@ (p) @L
=
@pi @pi y =y
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i
@pi @pi
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i 0
@pi @pi
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i 0
@pi @pi
where the inequality follows from convexity of the pro…t function.

Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i 0
@pi @pi
This is called the Law of Supply: quantity responds in the same direction as
prices.
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i 0
@pi @pi
prices.
Notice that here yi can be either input or output.
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i 0
@pi @pi
prices.
What does this mean for outputs?
Law of Supply
Remark

L=p y F (y )
@ (p) @L
= = yi (p)
@pi @pi y =y
Therefore, we have
@ 2 (p) @y (p)
= i 0
@pi @pi
prices.
What does this mean for outputs?
What does this mean for inputs?
Factor Demand, Supply, and Pro…t Function
The previous concepts can be stated using the production function notation.
De…nition
Given p 2 R++ and w 2 Rn++ and a production function f : Rn+ ! R+ , the …rm’s
factor demand is
x (p; w ) = arg max fpy w x subject to f (x) = y g
x
De…nition
factor demand is
x (p; w ) = arg max fpy w x subject to f (x) = y g = arg max pf (x) w x:
x x
De…nition
factor demand is
x x
De…nition
supply y : Rn+ ! R is de…ned by
y (p; w ) = f (x (p; w )) :
De…nition
factor demand is
x x
De…nition
supply y : Rn+ ! R is de…ned by
y (p; w ) = f (x (p; w )) :
De…nition
pro…t function : R++ Rn++ ! R is de…ned by
(p; w ) = py (p; w ) w x (p; w ) :
Factor Demand Properties
Given these de…nitions, the following results “translate” the results for output
sets to production functions.
Proposition
Given p 2 R++ and w 2 Rn++ and a production function f : Rn+ ! R+ ,
1 (p; w ) is convex in (p; w ).
@y (p;w )
2 y (p; w ) is non decreasing in p (i.e. @p 0) and x (p; w ) is non
@xi (p;w )
increasing in w (i.e. @w i 0) (Hotelling’s Lemma).
Factor Demand Properties
Given these de…nitions, the following results “translate” the results for output
sets to production functions.
Proposition
Given p 2 R++ and w 2 Rn++ and a production function f : Rn+ ! R+ ,
1 (p; w ) is convex in (p; w ).
@y (p;w )
2 y (p; w ) is non decreasing in p (i.e. @p 0) and x (p; w ) is non
@xi (p;w )
increasing in w (i.e. @w i 0) (Hotelling’s Lemma).
Proof.
Problem 7a,b; Problem Set 4.
Cost Minimization
Cost Minimizing
Consider the single output case and suppose the …rm wants to deliver a given
output quantity at the lowest possible costs. The …rm solves
min w x subject to f (x) = y

Cost Minimization
Cost Minimizing
This has no simple equivalent in the output vector notation.

Cost Minimization
Cost Minimizing
De…nition
Given w 2 Rn++ and a production function f : Rn+ ! R+ , the …rm’s conditional
factor demand is
x (w ; y ) = arg min fw x subject to f (x) = y g ;
Cost Minimization
Cost Minimizing
De…nition
Given w 2 Rn++ and a production function f : Rn+ ! R+ , the …rm’s conditional
factor demand is
x (w ; y ) = arg min fw x subject to f (x) = y g ;
De…nition
Given w 2 Rn++ and a production function f : Rn+ ! R+ , the …rm’s cost function
C : Rn++ R+ ! R is de…ned by
C (w ; y ) = w x (w ; y ) :
Properties of Cost Functions
Proposition
Given a production function f : Rn+ ! R+ , the corresponding cost function C (w ; y )
is concave in w .
Proof.
Question 7c; Problem Set 4. (Hint: use a ‘revealed preferences’argument)
Proposition
is concave in w .
Proof.
Shephard’s Lemma
Proposition
is concave in w .
Proof.
Shephard’s Lemma
L=w x [f (x) y]
Proposition
is concave in w .
Proof.
Shephard’s Lemma
L=w x [f (x) y]
by the Envelope Theorem
@C (w ; y ) @L
= = xi (w ; y )
@wi @wi
Proposition
is concave in w .
Proof.
Shephard’s Lemma
L=w x [f (x) y]
by the Envelope Theorem
@C (w ; y ) @L
= = xi (w ; y )
@wi @wi
Conditional factor demands are downward sloping

2
(w ;y ) @xi (w ;y )
Di¤erentiating one more time: @C @w i @w i = @w i 0 where the
inequality follows concavity of C (w ; y ).
Next Class
Decision Making Under Uncertainty

Expected Utility Representation

GARP and Afriat&#39;s Theorem

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GARP and Afriat’s Theorem

Econ 2100 Fall 2018

fx j ; p j ; w j gNj=1 is a …nite set of demand data that satisfy p j x j wj.

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

If a choice is directly revealed weakly prefered to a bundle, this bundle cannot

Problem 4, Problem Set 4.

This de…nition can alternatively be stated by the condition

This de…nition can alternatively be stated by the condition

For …nite data, the only implication of preference maximization is GARP;

For …nite data, the only implication of preference maximization is GARP;

For …nite data, the only implication of preference maximization is GARP;

For …nite data, the only implication of preference maximization is GARP;

Where are the Afriat’s numbers coming from?

Where are the Afriat’s numbers coming from?

Where are the Afriat’s numbers coming from?

The solution maximizes the Lagrangean:

Where are the Afriat’s numbers coming from?

The solution maximizes the Lagrangean:

Where are the Afriat’s numbers coming from?

The solution maximizes the Lagrangean:

Where are the Afriat’s numbers coming from?

The solution maximizes the Lagrangean:

Another intuition behind Afriat’s numbers

The standard undergraduate textbook description focuses on one ouput and a

The standard undergraduate textbook description focuses on one ouput and a

The standard undergraduate textbook description focuses on one ouput and a

The standard undergraduate textbook description focuses on one ouput and a

The standard undergraduate textbook description focuses on one ouput and a

y = (y1 ; :::; yN ) denotes production (input-output) vectors.

The standard undergraduate textbook description focuses on one ouput and a

y = (y1 ; :::; yN ) denotes production (input-output) vectors.

The standard undergraduate textbook description focuses on one ouput and a

y = (y1 ; :::; yN ) denotes production (input-output) vectors.

Some of these properties are related to each other.

Some of these properties are related to each other.

Pro…t Maximizing Assumption

Pro…t Maximizing Assumption

Does this distinguish between revenues and costs? How?

Pro…t Maximizing Assumption

Does this distinguish between revenues and costs? How?

Pro…t Maximizing Assumption

Does this distinguish between revenues and costs? How?

the Marginal Rate of Transformation equals the price ratio.

Tracks the optimal choice as prices change (similar to Walrasian demand).

Tracks the optimal choice as prices change (similar to Walrasian demand).

Tracks the optimal choice as prices change (similar to Walrasian demand).

Tracks maximized pro…ts as prices change (similar to indirect utility function).

Tracks the optimal choice as prices change (similar to Walrasian demand).

Tracks maximized pro…ts as prices change (similar to indirect utility function).

multiplying by and 1 we get

multiplying by and 1 we get

multiplying by and 1 we get

because p y is linear in p and Dp F (y ) = 0.

because p y is linear in p and Dp F (y ) = 0.

Write the Lagrangian

Write the Lagrangian

Write the Lagrangian

Write the Lagrangian

GARP and Afriat's Theorem

GARP and Afriat's Theorem