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 Chapter 3:
Consumer Preferences and the
Concept of Utility
Spring 2021
Kota Murayama
The Chinese University of Hong Kong
Introduction
• Markets in economic models: buyers, sellers, and market prices

• Ch.3-5 study the behavior of buyers in markets

• We often call buyers consumers

• Consumers decide what and how much to consume based on their

preferences over different kinds of products or services (called bundles)
under consideration

• what to eat, where to live, which job to take, …

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Preferences
• Consumers have preferences over bundles

• Example of bundles: {𝑎𝑝𝑝𝑙𝑒, 𝑏𝑎𝑛𝑎𝑛𝑎, 𝑜𝑟𝑎𝑛𝑔𝑒}

• Example of preferences: “I prefer apple to banana”, “I prefer banana to orange”, and

“I prefer apple to orange”

• Thus, preference is a ranking of bundles

• Indifferences are also possible: “I like apple as much as banana”

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Definition: Consumer Preference
• Symbol ≻ defines a ranking for two different bundles:
“𝑎𝑝𝑝𝑙𝑒 ≻ 𝑏𝑎𝑛𝑎𝑛𝑎” = “I prefer apple to banana”

• Symbol ~ is for indifferences:

“𝑎𝑝𝑝𝑙𝑒 ~ 𝑏𝑎𝑛𝑎𝑛𝑎” = “I like apple as much as banana”

• A pair of two symbols (≻, ~) is a person’s preference

• We make three assumptions to consider a “rational” consumer

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Assumption 1: Completeness
• A preference relation (≻, ~) is complete if she can compare any bundles

• For any pair 𝑋 and Y, we have either X ≻ 𝑌 , Y ≻ 𝑋, or 𝑋~𝑌

• Thus, the consumer must like one more than the other, or like them
equally well

• Reasonable?

• How many complete preferences exist for {𝑎𝑝𝑝𝑙𝑒, 𝑏𝑎𝑛𝑎𝑛𝑎, 𝑜𝑟𝑎𝑛𝑔𝑒}?

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Assumption 2: Transitivity
• A preference relation (≻, ~) is transitive if her choice is “consistent”

• 𝑎𝑝𝑝𝑙𝑒 ≻ 𝑏𝑎𝑛𝑎𝑛𝑎 and 𝑏𝑎𝑛𝑎𝑛𝑎 ≻ 𝑜𝑟𝑎𝑛𝑔𝑒, then 𝑎𝑝𝑝𝑙𝑒 ≻ 𝑜𝑟𝑎𝑛𝑔𝑒

• For any triple 𝑋 , Y, and Z, if X ≻ 𝑌 and Y ≻ 𝑍 then X ≻ 𝑍 (same for ~)

• Reasonable?

• “A cup of coffee with 𝑋 gram of sugar ” ~ “a cup of coffee with

𝑋 – 𝜀 gram of sugar ”?

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Assumption 3: More is better
• Having more of a good is better for the consumer

• Choose how many apples (𝑥) and bananas (𝑦) to consume

• (𝑥 + 1, 𝑦) ≻ (𝑥, 𝑦) and (𝑥, 𝑦 + 1) ≻ (𝑥, 𝑦)

• Restrictive, mainly to simplify the analysis

• Money, education, …

• Not always true but may be true for up to some amount

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Preferences to Utility
• Utility function 𝑈 P assigns a number to each bundle so that more
preferred bundle has a higher number than less preferred bundle

• 𝑎𝑝𝑝𝑙𝑒 ≻ 𝑏𝑎𝑛𝑎𝑛𝑎 and 𝑏𝑎𝑛𝑎𝑛𝑎 ≻ 𝑜𝑟𝑎𝑛𝑔𝑒

• 𝑈 𝑎𝑝𝑝𝑙𝑒 = 3, 𝑈 𝑏𝑎𝑛𝑎𝑛𝑎 = 2, 𝑎𝑛𝑑 𝑈 𝑜𝑟𝑎𝑛𝑔𝑒 = 1

• When a preference relation (≻, ~) satisfies the three assumptions, we can

always find a utility function that gives the same ranking with (≻, ~):
𝑋 ≻ 𝑌 → 𝑈 𝑋 > 𝑈(𝑌) and 𝑋 ~ 𝑌 → 𝑈 𝑋 = 𝑈(𝑌)

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Implications of Utility Function
• It is an ordinal concept

• The precise magnitude of the number that the function assigns has no
significance

• Utility not comparable across individuals

• Different utility functions can represent a same preference

• U! 𝑥, 𝑦 = 𝑥 + 𝑦, U" 𝑥, 𝑦 = 2𝑥 + 2𝑦, and U# 𝑥, 𝑦 = (𝑥 + 𝑦)"

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Case of Two Goods
• Choose how much of good 1 and good 2 to consume (e.g., apple and banana)

• For simplicity, suppose that a consumer can consume any amount of each good
(e.g., 0.1 gram of apple, 0.001 gram of banana, …)

• 𝑥 ≥ 0: amount of good 1 to be consumed

• 𝑦 ≥ 0: amount of good 2 to be consumed

• 𝑈! 𝑥, 𝑦 = 𝑥 + 𝑦

• 𝑈" 𝑥, 𝑦 = 𝑥

• 𝑈# 𝑥, 𝑦 = 𝑥𝑦 …

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Review: Utility Function
• Utility function 𝑈 P assigns a number to each bundle so that more
preferred bundle has a higher number than less preferred bundle

• Bundle with higher utility is more preferred by the consumer

• Example: 𝑎𝑝𝑝𝑙𝑒 ≻ 𝑏𝑎𝑛𝑎𝑛𝑎 and 𝑏𝑎𝑛𝑎𝑛𝑎 ≻ 𝑜𝑟𝑎𝑛𝑔𝑒

• 𝑈 𝑎𝑝𝑝𝑙𝑒 = 3, 𝑈 𝑏𝑎𝑛𝑎𝑛𝑎 = 2, 𝑎𝑛𝑑 𝑈 𝑜𝑟𝑎𝑛𝑔𝑒 = 1

• 𝑈 𝑎𝑝𝑝𝑙𝑒 = 300, 𝑈 𝑏𝑎𝑛𝑎𝑛𝑎 = 200, 𝑎𝑛𝑑 𝑈 𝑜𝑟𝑎𝑛𝑔𝑒 = 100

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Review: Choice Environments
• Choose how much of good 1 and good 2 to consume (e.g., apple and banana)

• For simplicity, suppose that a consumer can consume any amount of each good
(e.g., 0.1 gram of apple, 0.001 gram of banana, …)

• 𝑥 ≥ 0: amount of good 1 to be consumed

• 𝑦 ≥ 0: amount of good 2 to be consumed

• 𝑈! 𝑥, 𝑦 = 𝑥 + 𝑦

• 𝑈" 𝑥, 𝑦 = 𝑥

• 𝑈# 𝑥, 𝑦 = 𝑥𝑦 …

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Marginal Utility
• Marginal Utility of good 1 is the additional utility that the consumer
obtains from consuming a little more of good 1 given the amount of good
2 fixed

• In other words, the rate at which total utility changes as the level of
consumption of good 1 increases

%&($,)) %&($,))
• In math, 𝑀𝑈$ = %$
(𝑀𝑈) = %)
for good 2)

• In graph, it is the slope of the utility function

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 !
Example:𝑈(𝑥, 𝑦) = 10𝑥 − 𝑥

U(x) = 10x – x2 MUX = 10 – 2X

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More Examples of Marginal Utility
• 𝑈 𝑥, 𝑦 = 𝑥 + 𝑦 ⟹ 𝑀𝑈$ = 𝑀𝑈) = 1

• 𝑈 𝑥, 𝑦 = 𝑥 ⟹ 𝑀𝑈$ = 1, 𝑀𝑈) =0

• 𝑈 𝑥, 𝑦 = 𝑥𝑦 ⟹ 𝑀𝑈$ = 𝑦, 𝑀𝑈) = 𝑥

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Principle of Diminishing Marginal Utility
• When marginal utility decreases as
the consumer consumes more of
good 1, we say that the consumer
shows diminishing marginal utility
with respect to good 1

• In math, 𝑀𝑈$ is decreasing in 𝑥

given 𝑦 fixed if

𝜕𝑀𝑈$
<0
𝜕𝑥

• Example: 𝑈 𝑥, 𝑦 = 𝑥
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Indifference Curves
• Indifference curve: A collection of all bundles that give the consumer
same utility level (= bundles for which the consumer is indifferent)

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Indifference curves have negative slopes

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Indifference curves cannot intersect

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Indifference curves are not “thick”

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Marginal Rate of Substitution
• Idea: the amount of good 2 that
consumer can sacrifice in order to
consume one more unit of good 1
and keep the same utility level

• We call this the marginal rate of

substitution of 𝑥 for 𝑦 and write
𝑀𝑅𝑆$,)

• In graph, 𝑀𝑅𝑆$,) is the negative of

the slope of the indifference curve

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Marginal Rate of Substitution (con’t)

+&$
• In math, 𝑀𝑅𝑆$,) =
+&)

• Δ𝑈 = 𝑀𝑈$ Δ𝑥 + 𝑀𝑈) Δ𝑦

• Set Δ𝑈 = 0

,) +&$
•− =
,$ +&)

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Principle of Diminishing Marginal Rate of Substitution
• When 𝑀𝑅𝑆!,# decreases as the consumer
consumes more of good 1, we say that the
consumer shows diminishing marginal
rate of substitution

• In math, 𝑀𝑅𝑆!,# is decreasing in 𝑥 with 𝑦

fixed

• In graph, indifference curves are convex

to the origin

• Consumers prefer a mix of bundles

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Learning-By-Doing Exercise 3.3 (P. 93)
• Suppose a consumer has a utility function 𝑈(𝑥, 𝑦) = 𝑥𝑦

1. Marginal utilities for 𝑥 and 𝑦

2. Marginal rate of substitution of 𝑥 for 𝑦

3. Diminishing marginal rate of substitution?

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Learning-By-Doing Exercise 3.4 (P. 94)
• Suppose a consumer has a utility function 𝑈(𝑥, 𝑦) = 𝐴𝑥 " + 𝐵𝑦 " , where
𝐴, 𝐵 > 0

1. Marginal utilities for 𝑥 and 𝑦

2. Marginal rate of substitution of 𝑥 for 𝑦

3. Diminishing marginal rate of substitution?

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Typical Utility Functions
• Perfect substitutes

• Perfect complements

• The Cobb-Douglas utility function

• Quasilinear utility function

Copyright (c)2020 John Wiley & Sons, Inc.

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Perfect Substitutes
• Consumers do not mind replacing
one good with another

• Example: different brands of water

• 𝑈 𝑥, 𝑦 = 𝑥 + 𝑦
(or 𝑥 + 𝑘𝑦, 𝑘 > 0 more generally)

• Constant 𝑀𝑅𝑆!,#

• The indifference curves are straight

line

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Perfect Complements
• Consumers want to consume two
goods at the same time

• Left and right shoes

• 𝑈 𝑥, 𝑦 = min{ 𝑥, 𝑦}
(or min{𝑥, 𝑘𝑦}, 𝑘 > 0 more
generally)

• The indifference curves are kinked

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Cobb-Douglas Utility Function
• A function of the form
𝑈 𝑥, 𝑦 = 𝐴𝑥 - 𝑦 . , where
𝐴, 𝛼, and 𝛽 are positive constants

• Have many useful properties for

analysis

• Show diminishing MRS (True?)

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Quasilinear Utility Function
• A function of the form
𝑈(𝑥, 𝑦) = 𝑣 𝑥 + 𝑦

• Assume v(0)=0

• 𝑈 is linear in one of the goods

consumed (𝑦), but may be nonlinear
in the other (𝑣(𝑥))

• Utility from good 1 can be translated

into money (𝑦)

• The indifference curves are parallel

for a given 𝑥 (why?)

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Suggested textbook reading and review questions
• Reading: 3.1, 3.2, 3.3

• Learning-By-Doing Exercises: 3.1, 3.2, 3.3, 3.4

• Review Questions (p. 105): 2, 4, 5, 9, 10, 11

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