KTHVM-chương-1

Don’t Do
1
Hi!
Lecturer: PhD. Dang Trung Tuyen
Add: Faculty of Political Economy-

VNU-UEB
Tel: 0379 561 581
Email:
mbatrungtuyen.dang@gmail.com 2
LECTURER’s
INFOMATION
EDUCATION LEVEL EXPERIENCE
- MBA– VNU – UEB (2014) - Commercial representative in

north east area, China of HAG
Agrico
- PhD in Management –
Beijing Forestry University, - Visiting lecturer at FPT
China University
- Lecturer at PFE - UEB
3
COURSE
COURSE
- Group presentation: 6 – 8 students

per group
- Final exam: Seeing final exam
structure 5
CONTENT
Topic 1. CONSUMER BEHAVIOR
Topic 2. OPTIMAL CHOICE
Topic 3. CONSUMER CHOICE
Topic 4. TECHNOLOGY, COST AND
PROFIT
Topic 5. PURE COMPETITION
Topic 6. MONOPOLY
Topic 7. OLIGOPOLY
Topic 8. GENERAL EQUILIBRIUM5
TOPIC 1:
CONSUMER BEHAVIOR
TOPIC 1: Preferences
CONSUMER
BEHAVIOR
RATIONALITY IN ECONOMICS
Behavioral Postulate:
So to model choice we
A decisionmaker always
must model
chooses its most preferred
decisionmakers’
alternative from its set of
preferences.
available alternatives.
PREFERENCE RELATIONS
• Comparing two different consumption bundles, x

and y:
• strict preference: x is more preferred than is y.
• weak preference: x is as at least as preferred as
is y.
• indifference: x is exactly as preferred as is y.
Strict preference, weak preference and

indifference are all preference relations.
Particularly, they are ordinal relations; i.e. they

state only the order in which bundles are
preferred.
• denotes strict preference;

p
p
x y means that bundle x is preferred
strictly to bundle y.
p
• denotes strict preference;
p
x y means bundle x is preferred strictly to
bundle y.
• ~ denotes indifference; x ~ y means x and y
are equally preferred.
p
• denotes strict preference so
p
x y means that bundle x is preferred strictly to
bundle y.
• ~ denotes indifference; x ~ y means x and y are
equally preferred.
• f~ denotes weak preference;
x f y means x is preferred at least as much as is y.
~
•x f~y and y ~
f x imply x ~ y.
•x f~ y and y ~f x imply x ~ y.
•x ~f y and (not y ~f x) imply x p

y.
ASSUMPTIONS ABOUT
• Completeness: For any two bundles x and

y it is always possible to make the
statement that either
x fy
~
or
y fx.
~
ASSUMPTIONS ABOUT
• Reflexivity: Any bundle x is always

at least as preferred as itself; i.e.
x f~x.
ASSUMPTIONS ABOUT
• Transitivity: If
x is at least as preferred as y, and
y is at least as preferred as z, then
x is at least as preferred as z; i.e.
x f~y and y ~
fz x f~z.
INDIFFERENCE CURVES
• Take a reference bundle x’. The set of all

bundles equally preferred to x’ is the
indifference curve containing x’; the set of
all bundles y ~ x’.
• Since an indifference “curve” is not always
a curve a better name might be an
indifference “set”.
INDIFFERENCE CURVES
x2
x’ x’ ~ x” ~ x”’
x”
x”’
x1
INDIFFERENCE CURVES
x2
p p
z x y
x
x1
INDIFFERENCE CURVES
I1
x2
x All bundles in I1 are
strictly preferred to all
z in I2.
I2
All bundles in I2 are

y strictly preferred to
I3 all in I3.
x1
INDIFFERENCE CURVES
x2
WP(x), the set of
x bundles weakly
preferred to x.
I(x) I(x’)
x1
INDIFFERENCE CURVES
x2
WP(x), the set of
x bundles weakly
preferred to x.
WP(x)
includes
I(x) I(x).
x1
INDIFFERENCE CURVES
x2
SP(x), the set of
x bundles strictly
preferred to x,
does not
include
I(x) I(x).
x1
INDIFFERENCE CURVES CANNOT INTERSECT
x2 I2
I1
From I1, x ~ y. From I2, x ~ z.
Therefore y ~ z.
x
y
z
x1
INDIFFERENCE CURVES CANNOT INTERSECT
x2 I2
I1 From I1, x ~ y. From I2, x ~ z.
Therefore y ~ z. But from I1
p
and I2 we see y z, a
x contradiction.
y
z
x1
SLOPES OF INDIFFERENCE
CURVES
• When more of a commodity is always

preferred, the commodity is a good.
• If every commodity is a good then
indifference curves are negatively sloped.
GoodCURVES
2
Two goods
Be a negatively sloped
tte
r indifference curve.
W
or
se
Good 1
CURVES
• If less of a commodity is always

preferred then the commodity is a
bad.
GoodCURVES
2
One good and one
r bad a
t t e
e positively sloped
B
indifference curve.
se
o r
W
Bad 1
EXTREME CASES OF
INDIFFERENCE CURVES;
PERFECT SUBSTITUTES
• If a consumer always regards units of
commodities 1 and 2 as equivalent, then
the commodities are perfect substitutes and
only the total amount of the two
commodities in bundles determines their
preference rank-order.
EXTREME CASES OF
x2 PERFECT SUBSTITUTES
Slopes are constant at - 1.
15 I2
Bundles in I2 all have a total
8 of 15 units and are strictly
preferred to all bundles in
I1 I1, which have a total of
only 8 units in them.
8 15 x1
EXTREME CASES OF
PERFECT COMPLEMENTS
• If a consumer always consumes
commodities 1 and 2 in fixed proportion
(e.g. one-to-one), then the commodities are
perfect complements and only the number
of pairs of units of the two commodities
determines the preference rank-order of
bundles.
EXTREME CASES OF
x2 PERFECT COMPLEMENTS
45o Each of (5,5), (5,9)
and (9,5) contains
5 pairs so each is
equally preferred.
9
5 I1
5 9 x1
EXTREME CASES OF
x2 PERFECT COMPLEMENTS
45o Since each of (5,5),
(5,9) and (9,5)
contains 5 pairs,
each is less
9 I2 preferred than the
bundle (9,9) which
5 I1 contains 9 pairs.
5 9 x1
PREFERENCES EXHIBITING
SATIATION
• A bundle strictly preferred to any

other is a satiation point or a bliss
point.
• What do indifference curves look
like for preferences exhibiting
satiation?
INDIFFERENCE CURVES
EXHIBITING SATIATION
x2
Satiation
(bliss)
point
x1
INDIFFERENCE CURVES
x2 Be
r tte tt e
Be Satiation
r (bliss)
Bette point
r
x1
INDIFFERENCE CURVES
x2 Be
r tte tt e
Be Satiation
r (bliss)
point
Bette
r
x1
INDIFFERENCE CURVES FOR
DISCRETE COMMODITIES
• A commodity is infinitely divisible if it can

be acquired in any quantity; e.g. water or
cheese.
• A commodity is discrete if it comes in unit
lumps of 1, 2, 3, … and so on; e.g. aircraft,
ships and refrigerators.
INDIFFERENCE CURVES FOR
DISCRETE COMMODITIES
• Suppose commodity 2 is an infinitely

divisible good (gasoline) while commodity
1 is a discrete good (aircraft). What do
indifference “curves” look like?
INDIFFERENCE CURVES WITH A
DISCRETE GOOD
Gas-
oline Indifference “curves”
are collections of
discrete points.
0 1 2 3 4 Aircraft
WELL-BEHAVED PREFERENCES
• A preference relation is “well-behaved” if

it is
• monotonic and convex.
• Monotonicity: More of any commodity is
always preferred (i.e. no satiation and
every commodity is a good).
• Convexity: Mixtures of bundles are (at

least weakly) preferred to the bundles
themselves. E.g., the 50-50 mixture of the
bundles x and y is
z = (0.5)x + (0.5)y.
z is at least as preferred as x or y.
-- CONVEXITY.
x2 x
x2+y2 x+y is strictly preferred

z=
2 to both x and y.
2
y
y2
x1 x1+y1 y1
2
-- CONVEXITY.
x2 x
z =(tx1+(1-t)y1, tx2+(1-t)y2)
is preferred to x and y
for all 0 < t < 1.
y
y2
x1 y1
-- CONVEXITY.
Preferences are strictly convex
x2 x when all mixtures z

are strictly
z preferred to their
component
bundles x and y.
y
y2
x1 y1
-- WEAK CONVEXITY.
Preferences are weakly

x’
convex if at least one
z’ mixture z is equally
preferred to a
x component bundle.
z
y
y’
NON-CONVEX PREFERENCES
x2
B
et
te
The mixture z
r
z is less preferred
than x or y.
y2
x1 y1
MORE NON-CONVEX
PREFERENCES
B
x2
et
te
The mixture z
r
z is less preferred
than x or y.
y2
x1 y1
CURVES
• The slope of an indifference curve is

its marginal rate-of-substitution
(MRS).
• How can a MRS be calculated?
MARGINAL RATE OF
SUBSTITUTION
x2
MRS at x’ is the slope of the
indifference curve at x’
x’
x1
MARGINAL RATE OF
SUBSTITUTION
x2
MRS at x’ is
lim {Dx2/Dx1}
Dx1 0
D x2 x’
= dx2/dx1 at x’
D x1
x1
MARGINAL RATE OF
SUBSTITUTION
x2 dx2 = MRS ´ dx1 so, at x’, MRS is
the rate at which the consumer
is only just willing to exchange
commodity 2 for a small amount
of commodity 1.
dx2 x’
dx1
x1
MRS & IND. CURVE PROPERTIES
Good 2
Two goods
B a negatively sloped
et indifference curve
te
r
MRS < 0.
W
or
se
Good 1
Good 2
One good and one
r bad a
t t e
e positively sloped
B
indifference curve
se MRS > 0.
o r
W
Bad 1
Good 2
MRS = - 5
MRS always increases with x1
(becomes less negative) if and
only if preferences are strictly
convex. „Coolidge effect”
MRS = - 0.5 Good 1

x2 MRS decreases
MRS = - 0.5
(becomes more negative)
as x1 increases
nonconvex preferences
MRS = - 5
x1
x2 MRS is not always increasing as

x1 increases nonconvex
MRS = - 1 preferences.
MRS
= - 0.5
MRS = - 2
x1
CHAPTER TWO
BUDGETARY AND OTHER CONSTRAINTS ON CHOICE
CONSUMPTION CHOICE SETS
A consumption choice set

is the collection of all What constrains
consumption choices consumption choice?
available to the consumer.
• Budgetary, time and
other resource
limitations.
BUDGET CONSTRAINTS
• A consumption bundle containing x1 units

of commodity 1, x2 units of commodity 2
and so on up to xn units of commodity n is
denoted by the vector (x1, x2, … , xn).
• Commodity prices are p1, p2, … , pn.

BUDGET CONSTRAINTS
• Q: When is a consumption bundle

(x1, … , xn) affordable at given prices
p1, … , pn?
BUDGET CONSTRAINTS
• Q: When is a bundle (x1, … , xn) affordable

at prices p1, … , pn?
• A: When
p 1 x 1 + … + pn x n £ m
where m is the consumer’s (disposable)
income.
BUDGET CONSTRAINTS
• The bundles that are only just affordable form the

consumer’s budget constraint. This is the set
{ (x1,…,xn) | x1 ³ 0, …, xn ³ 0 and
p1x1 + … + pnxn = m }.
BUDGET CONSTRAINTS
• The consumer’s budget set is the set of all

affordable bundles;
B(p1, … , pn, m) =
{ (x1, … , xn) | x1 ³ 0, … , xn ³ 0 and
p 1 x 1 + … + pn x n £ m }
• The budget constraint is the upper
boundary of the budget set.
BUDGET SET AND CONSTRAINT
FOR TWO COMMODITIES
x2
Budget constraint is
m /p2
p1x1 + p2x2 = m.
m /p1 x1
FOR TWO COMMODITIES
x2
m /p2
p1x1 + p2x2 = m.
m /p1 x1
FOR TWO COMMODITIES
x2
m /p2
p1x1 + p2x2 = m.
Just affordable
m /p1 x1
FOR TWO COMMODITIES
x2
m /p2
p1x1 + p2x2 = m.
Not affordable
Just affordable
m /p1 x1
FOR TWO COMMODITIES
x2
m /p2
p1x1 + p2x2 = m.
Not affordable
Just affordable
Affordable
m /p1 x1
FOR TWO COMMODITIES
x2
m /p2
p1x1 + p2x2 = m.
the collection
of all affordable bundles.
Budget
Set
m /p1 x1
FOR TWO COMMODITIES
x2
p1x1 + p2x2 = m is
m /p2
x2 = -(p1/p2)x1 + m/p2
so slope is -p1/p2.
Budget
Set
m /p1 x1
BUDGET CONSTRAINTS
• If n = 3 what do the budget constraint

and the budget set look like?
BUDGET CONSTRAINT FOR
THREE COMMODITIES
x2 p1x1 + p2x2 + p3x3 = m
m /p2
m /p3
x3
m /p1 x1
BUDGET SET FOR THREE
COMMODITIES
{ (x1,x2,x3) | x1 ³ 0, x2 ³ 0, x3 ³ 0 and
x2
m /p
p 1x 1 + p 2x 2 + p 3x 3 £ m}
2
m /p3
x3
m /p1
x1
BUDGET CONSTRAINTS
• For n = 2 and x1 on the horizontal axis, the constraint’s

slope is -p1/p2. What does it mean?
p1 m
x2   x1 
p2 p2
BUDGET CONSTRAINTS
• For n = 2 and x1 on the horizontal axis, the

constraint’s slope is -p1/p2. What does it mean?
p1 m
x2   x1 
p2 p2
• Increasing x1 by 1 must reduce x2 by p1/p2.
BUDGET CONSTRAINTS
x2
Slope is -p1/p2
-p1/p2
+1
x1
BUDGET CONSTRAINTS
x2
Opp. cost of an extra unit of
commodity 1 is p1/p2 units
-p1/p2 foregone of commodity 2.
+1
x1
BUDGET CONSTRAINTS
x2
Opp. cost of an extra unit of
commodity 1 is p1/p2 units
foregone of commodity 2. And
+1 the opp. cost of an extra
unit of commodity 2 is
-p2/p1 p2/p1 units foregone
of commodity 1.
x1
BUDGET SETS & CONSTRAINTS;
INCOME AND PRICE CHANGES
• The budget constraint and budget set

depend upon prices and income. What
happens as prices or income change?
HOW DO THE BUDGET SET AND
BUDGET CONSTRAINT CHANGE AS
INCOME M INCREASES?
x2
Original
budget set x1
HIGHER INCOME GIVES MORE
CHOICE
x2 New affordable consumption

choices
Original and
new budget
constraints are
parallel (same
Original slope).
budget set x
1
INCOME M DECREASES?
x2
Original
budget set
x1
INCOME M DECREASES?
x2
Consumption bundles
that are no longer
affordable.
Old and new
New, smaller constraints
budget set are parallel.
x1
BUDGET CONSTRAINTS -
INCOME CHANGES
• Increases in income m shift the constraint

outward in a parallel manner, thereby
enlarging the budget set and improving
choice.
INCOME CHANGES
• Increases in income m shift the constraint outward

in a parallel manner, thereby enlarging the budget
set and improving choice.
• Decreases in income m shift the constraint inward
in a parallel manner, thereby shrinking the budget
set and reducing choice.
INCOME CHANGES
• No original choice is lost and new choices

are added when income increases, so
higher income cannot make a consumer
worse off.
• An income decrease may (typically will)
make the consumer worse off.
BUDGET CONSTRAINTS - PRICE
CHANGES
• What happens if just one price

decreases?
• Suppose p1 decreases.
HOW DO THE BUDGET SET AND BUDGET
CONSTRAINT CHANGE AS P1 DECREASES
FROM P1’ TO P1”?
x2
m/p2
-p1’/p2
Original m/p1’ m/p1”

budget set x1
x2
m/p2
New affordable choices
-p1’/p2
Original
m/p1”
budget set
m/p1’ x1
x2
m/p2
New affordable choices
Budget constraint
-p1’/p2 pivots; slope flattens
from -p1’/p2 to
Original -p1”/p2
-p1”/p2
budget set
m/p1’ m/p1” x1
CHANGES
• Reducing the price of one commodity

pivots the constraint outward. No old
choice is lost and new choices are added,
so reducing one price cannot make the
consumer worse off.
CHANGES
• Similarly, increasing one price pivots

the constraint inwards, reduces
choice and may (typically will) make
the consumer worse off.
UNIFORM AD VALOREM SALES TAXES
• An ad valorem sales tax levied at a rate of

5% increases all prices by 5%, from p to
(1+0×05)p = 1×05p.
• An ad valorem sales tax levied at a rate of
t increases all prices by tp from p to
(1+t)p.
• A uniform sales tax is applied uniformly to
all commodities.
• A uniform sales tax levied at rate t changes

the constraint from
p1x1 + p2x2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
• A uniform sales tax levied at rate t changes the

constraint from
p1 x 1 + p2 x 2 = m
to
(1+t)p1x1 + (1+t)p2x2 = m
i.e.
p1x1 + p2x2 = m/(1+t).
x2
m p1x1 + p2x2 = m
p2
m
p1
x1
x2
m p1x1 + p2x2 = m
p2
m p1x1 + p2x2 = m/(1+t)
( 1  t ) p2
m
p1
m
( 1  t ) p1 x1
x2
m
p2 Equivalent income loss
is
m m t
m  m
( 1  t ) p2 1 t 1 t
m
p1
m x1
( 1  t ) p1
x2
m A uniform ad valorem
p2 sales tax levied at rate t
m is equivalent to an incom
( 1  t ) p2 tax levied at rate t
.
1 t
m m x1
( 1  t ) p1 p1
THE FOOD STAMP PROGRAM
• Food stamps are coupons that can be

legally exchanged only for food.
• How does a commodity-specific gift such
as a food stamp alter a family’s budget
constraint?
• Suppose m = $100, pF = $1 and the price

of “other goods” is pG = $1.
• The budget constraint is then
F + G =100.
G
F + G = 100; before stamps.
100
100 F
G F + G = 100: before stamps.

100
100 F
G F + G = 100: before stamps.

100 Budget set after 40 food
stamps issued.
40 100 140 F
G
F + G = 100: before stamps.
100 Budget set after 40 food
stamps issued.
The family’s budget
set is enlarged.
40 100 140 F
• What if food stamps can be traded on

a black market for $0.50 each?
G
120
Budget constraint after 40
100
food stamps issued.
Budget constraint with
black market trading.
40 100 140 F
G

120
100 Budget constraint after 40
food stamps issued.
Black market trading
makes the budget
set larger again.
40 100 140 F
RELATIVE PRICES
• “Numeraire” means “unit of account”.

• Suppose prices and income are measured
in dollars. Say p1=$2, p2=$3, m = $12.
Then the constraint is
2x1 + 3x2 = 12.
RELATIVE PRICES
• If prices and income are measured in cents,

then p1=200, p2=300, m=1200 and the
constraint is
200x1 + 300x2 = 1200,
the same as
2x1 + 3x2 = 12.
• Changing the numeraire changes neither the
budget constraint nor the budget set.
RELATIVE PRICES
• The constraint for p1=2, p2=3, m=12

2x1 + 3x2 = 12
is also 1.x1 + (3/2)x2 = 6,
the constraint for p1=1, p2=3/2, m=6. Setting p1=1
makes commodity 1 the numeraire and defines all
prices relative to p1; e.g. 3/2 is the price of
commodity 2 relative to the price of commodity 1.
RELATIVE PRICES
• Any commodity can be chosen as the

numeraire without changing the
budget set or the budget constraint.
BUDGET CONSTRAINTS - RELATIVE
PRICES
• p1=2, p2=3 and p3=6 

• price of commodity 2 relative to commodity 1 is
3/2,
• price of commodity 3 relative to commodity 1 is 3.
• Relative prices are the rates of exchange of
commodities 2 and 3 for units of commodity 1.
SHAPES OF BUDGET
CONSTRAINTS
• Q: What makes a budget constraint a

straight line?
• A: A straight line has a constant slope and
the constraint is
p 1 x 1 + … + pn x n = m
so if prices are constants then a constraint
is a straight line.
SHAPES OF BUDGET
CONSTRAINTS
• But what if prices are not constants?

• E.g. bulk buying discounts, or price
penalties for buying “too much”.
• Then constraints will be curved.
SHAPES OF BUDGET CONSTRAINTS -
QUANTITY DISCOUNTS
• Suppose p2 is constant at $1 but that p1=$2

for 0 £ x1 £ 20 and p1=$1 for x1>20.
QUANTITY DISCOUNTS
• Suppose p2 is constant at $1 but that p1=$2

for 0 £ x1 £ 20 and p1=$1 for x1>20. Then
the constraint’s slope is
{
- 2, for 0 £ x1 £ 20
-p1/p2 =
- 1, for x1 > 20
and the constraint is
SHAPES OF BUDGET CONSTRAINTS
WITH A QUANTITY DISCOUNT
x2 m = $100
100 Slope = - 2 / 1 = - 2
(p1=2, p2=1)
Slope = - 1/ 1 = - 1
(p1=1, p2=1)
20 50
80 x1
x2 m = $100
100 Slope = - 2 / 1 = - 2
(p1=2, p2=1)
Slope = - 1/ 1 = - 1
(p1=1, p2=1)
20 50
80 x1
x2 m = $100
100
Budget Constraint
Budget Set
20 50
80 x1
WITH A QUANTITY PENALTY
x2
Budget
Constraint
Budget Set
x1
ONE PRICE NEGATIVE
• Commodity 1 is stinky garbage. You are paid $2

per unit to accept it; i.e. p1 = - $2. p2 = $1.
Income, other than from accepting commodity 1, is
m = $10.
• Then the constraint is
- 2x1 + x2 = 10 or x2 = 2x1 + 10.
ONE PRICE NEGATIVE
x2 x2 = 2x1 + 10
Budget constraint’s slope is

-p1/p2 = -(-2)/1 = +2
10
x1
ONE PRICE NEGATIVE
x2
Budget set is
all bundles for
which x1 ³ 0,
x2 ³ 0 and
x2 £ 2x1 + 10.
10
x1
MORE GENERAL CHOICE SETS
• Choices are usually constrained by more

than a budget; e.g. time constraints and
other resources constraints.
• A bundle is available only if it meets every
constraint.
Other Stuff
At least 10 units of food

must be eaten to survive
Food
10
Other Stuff
Choice is also budget

constrained.
Budget Set
10 Food
Other Stuff
Choice is further restricted by a ti

constraint.
10 Food
So what is the choice set?

Other Stuff
10 Food
Other Stuff
10 Food
Other Stuff
The choice set is the

intersection of all of
the constraint sets.
10 Food
CHAPTER FOUR
UTILITY
PREFERENCES - A REMINDER
p
•x y: x is preferred strictly to y.
• x ~ y: x and y are equally preferred.
•x ~f y: x is preferred at least as much
as is y.
• Completeness: For any two bundles

x and y it is always possible to state
either that
fy
x ~
or that
y ~fx.
• Reflexivity: Any bundle x is always

at least as preferred as itself; i.e.
x f~x.
• Transitivity: If
x is at least as preferred as y, and
y is at least as preferred as z, then
x is at least as preferred as z; i.e.
x f~ y and y f z x f~z.
~
UTILITY FUNCTIONS
• A preference relation that is complete,

reflexive, transitive and continuous can be
represented by a continuous utility
function.
• Continuity means that small changes to a
consumption bundle cause only small
changes to the preference level.
UTILITY FUNCTIONS
• A utility function U(x) represents a preference

f~
relation if and only if:
p
x’ x” U(x’) > U(x”)
x’ px” U(x’) < U(x”)
x’ ~ x” U(x’) = U(x”).
UTILITY FUNCTIONS
• Utility is an ordinal (i.e. ordering) concept.

• E.g. if U(x) = 6 and U(y) = 2 then bundle x
is strictly preferred to bundle y. But x is
not preferred three times as much as is y.
UTILITY FUNCTIONS & INDIFF. CURVES
• Consider the bundles (4,1), (2,3) and (2,2).

p
• Suppose (2,3) (4,1) ~ (2,2).
• Assign to these bundles any numbers that preserve
the preference ordering;
e.g. U(2,3) = 6 > U(4,1) = U(2,2) = 4.
• Call these numbers utility levels.
• An indifference curve contains equally

preferred bundles.
• Equal preference  same utility level.
• Therefore, all bundles in an indifference
curve have the same utility level.
• So the bundles (4,1) and (2,2) are in the indiff.

curve with utility level U º 4
• But the bundle (2,3) is in the indiff. curve with
utility level U º 6.
• On an indifference curve diagram, this preference
information looks as follows:
x2 p
(2,3) (2,2) ~ (4,1)
Uº6
Uº4
x1
• Another way to visualize this same

information is to plot the utility level
on a vertical axis.
3D plot of consumption & utility levels for 3 bundles
Utility U(2,3) = 6
U(2,2) = 4
U(4,1) = 4
x2
x1
• This 3D visualization of preferences

can be made more informative by
adding into it the two indifference
curves.
Utility
Uº6
Uº4 Higher indifference

curves contain
x2 more preferred
bundles.
x1
• Comparing more bundles will create a

larger collection of all indifference curves
and a better description of the consumer’s
preferences.
x2
Uº6
Uº4
Uº2
x1
• As before, this can be visualized in 3D by

plotting each indifference curve at the
height of its utility index.
Utility
Uº6
Uº5
Uº4
x2 Uº3
Uº2
Uº1
x1
• Comparing all possible consumption bundles gives

the complete collection of the consumer’s
indifference curves, each with its assigned utility
level.
• This complete collection of indifference curves
completely represents the consumer’s preferences.
x2
x1
x2
x1
x2
x1
x2
x1
x2
x1
x2
x1
x1
x1
x1
x1
x1
x1
x1
x1
x1
x1
• The collection of all indifference curves

for a given preference relation is an
indifference map.
• An indifference map is equivalent to a
utility function; each is the other.
UTILITY FUNCTIONS
• There is no unique utility function

representation of a preference relation.
• Suppose U(x1,x2) = x1x2 represents a
preference relation.
• Again consider the bundles (4,1),
(2,3) and (2,2).
UTILITY FUNCTIONS
• U(x1,x2) = x1x2, so
U(2,3) = 6 > U(4,1) = U(2,2) = 4;

p
that is, (2,3) (4,1) ~ (2,2).
UTILITY FUNCTIONS
p
• U(x1,x2) = x1x2 (2,3) (4,1) ~ (2,2).
• Define V = U2.
UTILITY FUNCTIONS
p
• U(x1,x2) = x1x2 (2,3) (4,1) ~ (2,2).
• Define V = U2.
• Then V(x1,x2) = x12x22 and
V(2,3) = 36 > V(4,1) = V(2,2) = 16
so again
p
(2,3) (4,1) ~ (2,2).
• V preserves the same order as U and so represents the
same preferences.
UTILITY FUNCTIONS
p
• U(x1,x2) = x1x2 (2,3) (4,1) ~ (2,2).
• Define W = 2U + 10.
UTILITY FUNCTIONS
p
• U(x1,x2) = x1x2 (2,3) (4,1) ~ (2,2).
• Define W = 2U + 10.
• Then W(x1,x2) = 2x1x2+10 so
W(2,3) = 22 > W(4,1) = W(2,2) = 18. Again,
p
(2,3) (4,1) ~ (2,2).
• W preserves the same order as U and V and so represents the
same preferences.
UTILITY FUNCTIONS
• If
• U is a utility function that represents a
preference relation ~ f and
• f is a strictly increasing function,
• then V = f(U) is also a utility function
representing f.
~
GOODS, BADS AND NEUTRALS
• A good is a commodity unit which increases utility

(gives a more preferred bundle).
• A bad is a commodity unit which decreases utility
(gives a less preferred bundle).
• A neutral is a commodity unit which does not
change utility (gives an equally preferred bundle).
GOODS, BADS AND NEUTRALS
Utility
Utility
function
Units of Units of
water are water are
goods bads
x’ Water
Around x’ units, a little extra water is a neutral.

SOME OTHER UTILITY
FUNCTIONS AND THEIR
INDIFFERENCE CURVES
• Instead of U(x1,x2) = x1x2 consider
V(x1,x2) = x1 + x2.
What do the indifference curves for this “perfect

substitution” utility function look like?
PERFECT SUBSTITUTION
INDIFFERENCE CURVES
x2 x1 + x 2 = 5
13
x1 + x 2 = 9
9
x1 + x2 = 13
5
V(x1,x2) = x1 + x2.
5 9 13 x1
PERFECT SUBSTITUTION
INDIFFERENCE CURVES
x2
x1 + x 2 = 5
13
x1 + x 2 = 9
9
x1 + x2 = 13
5
V(x1,x2) = x1 + x2.
5 9 13 x1 All are linear and

SOME OTHER UTILITY
FUNCTIONS AND THEIR
INDIFFERENCE CURVES
• Instead of U(x1,x2) = x1x2 or
V(x1,x2) = x1 + x2, consider
W(x1,x2) = min{x1,x2}.
What do the indifference curves for this “perfect

complementarity” utility function look like?
PERFECT COMPLEMENTARITY
INDIFFERENCE CURVES
x2
45o
W(x1,x2) = min{x1,x2}
8 min{x1,x2} = 8
5 min{x1,x2} = 5
3 min{x1,x2} = 3
3 5 8 x1
PERFECT COMPLEMENTARITY
INDIFFERENCE CURVES
45o
x2
W(x1,x2) = min{x1,x2}
8 min{x1,x2} = 8
5 min{x1,x2} = 5
3 min{x1,x2} = 3All are right-angled with

vertices on a ray
from the origin.
3 5 8 x1
SOME OTHER UTILITY
FUNCTIONS AND THEIR
INDIFFERENCE CURVES
• A utility function of the form
U(x1,x2) = f(x1) + x2
is linear in just x2 and is called quasi-linear.
• E.g. U(x1,x2) = 2x11/2 + x2.

QUASI-LINEAR INDIFFERENCE
x2
CURVES
Each curve is a vertically shifted copy of the others.
x1
SOME OTHER UTILITY
FUNCTIONS AND THEIR
INDIFFERENCE CURVES
• Any utility function of the form
U(x1,x2) = x1a x2b
with a > 0 and b > 0 is called a Cobb-Douglas

utility function.
• E.g. U(x1,x2) = x11/2 x21/2 (a = b = 1/2)
V(x1,x2) = x1 x23 (a = 1, b = 3)
COBB-DOUGLAS INDIFFERENCE
CURVES
x2
All curves are hyperbolic,

asymptoting to, but never
touching any axis.
x1
MARGINAL UTILITIES
• Marginal means “incremental”.

• The marginal utility of commodity i is the rate-of-
change of total utility as the quantity of
commodity i consumed changes; i.e.
U
MU i 
 xi
MARGINAL UTILITIES
• E.g. if U(x1,x2) = x11/2 x22 then
 U 1  1/ 2 2
MU1   x1 x2
 x1 2
MARGINAL UTILITIES
• E.g. if U(x1,x2) = x11/2 x22 then
 U 1  1/ 2 2
MU1   x1 x2
 x1 2
MARGINAL UTILITIES
• E.g. if U(x1,x2) = x11/2 x22 then
U 1/ 2
MU 2   2 x1 x2
 x2
MARGINAL UTILITIES
• E.g. if U(x1,x2) = x11/2 x22 then
U 1/ 2
MU 2   2 x1 x2
 x2
MARGINAL UTILITIES
• So, if U(x1,x2) = x11/2 x22 then

 U 1  1/ 2 2
MU1   x1 x2
 x1 2
U 1/ 2
MU 2   2 x1 x2
 x2
MARGINAL UTILITIES AND MARGINAL
RATES-OF-SUBSTITUTION
• The general equation for an indifference curve is

U(x1,x2) º k, a constant.
Totally differentiating this identity gives
U U
dx1  dx2  0
 x1  x2
U U
dx1  dx2  0
 x1  x2
rearranged is
U U
dx2   dx1
 x2  x1
And
U U
dx2   dx1
 x2  x1
rearranged is
d x2  U /  x1
 .
d x1  U /  x2
This is the MRS.
MARG. UTILITIES & MARG.
RATES-OF-SUBSTITUTION; AN
EXAMPLE
• Suppose U(x1,x2) = x1x2. Then
U
 ( 1)( x2 )  x2
 x1
U
 ( x1 )( 1)  x1
 x2
d x2  U /  x1 x2
so
MRS    .
d x1  U /  x2 x1
MARG. UTILITIES & MARG.
RATES-OF-SUBSTITUTION; AN
EXAMPLE U(x ,x ) = x x ;
x2
1 2 1 2
x2
MRS  
8
x1
MRS(1,8) = - 8/1 = -8
MRS(6,6) = - 6/6 = -1.
6
U = 36
U=8
1 6 x1
MARG. RATES-OF-SUBSTITUTION FOR
QUASI-LINEAR UTILITY FUNCTIONS
• A quasi-linear utility function is of the form U(x1,x2) = f(x1)

+ x 2.
U U
 f ( x1 ) 1
 x1  x2
d x2  U /  x1
so
MRS     f  ( x1 ).
d x1  U /  x2
QUASI-LINEAR UTILITY FUNCTIONS
• MRS = - f¢ (x1) does not depend upon x2

so the slope of indifference curves for a
quasi-linear utility function is constant
along any line for which x1 is constant.
What does that make the indifference map
for a quasi-linear utility function look like?
x2 QUASI-LINEAR UTILITY FUNCTIONS
MRS =
- f(x1’) Each curve is a vertically shifted copy of the others.
MRS = -f(x1”)
MRS is a constant
along any line for which x1
is constant.
x1
x1 ’ x1 ”
MONOTONIC TRANSFORMATIONS &
MARGINAL RATES-OF-SUBSTITUTION
• Applying a monotonic transformation to a utility function

representing a preference relation simply creates another
utility function representing the same preference relation.
• What happens to marginal rates-of-substitution when a
monotonic transformation is applied?
• For U(x1,x2) = x1x2 the MRS = - x2/x1.
• Create V = U2; i.e. V(x1,x2) = x12x22. What is the MRS for

V? 2
 V /  x1 2 x1 x 2 x2
MRS    
 V /  x2 2
2 x1 x2 x1
which is the same as the MRS for U.

• More generally, if V = f(U) where f is a strictly

increasing function, then
 V /  x1 f  (U )   U / x1
MRS    
 V /  x2 f ' (U )   U / x 2
 U /  x1
 .
 U /  x2
So MRS is unchanged by a positive monotonic
transformation.

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Add: Faculty of Political Economy-

EDUCATION LEVEL EXPERIENCE

- MBA– VNU – UEB (2014) - Commercial representative in

- Group presentation: 6 – 8 students

• Comparing two different consumption bundles, x

Strict preference, weak preference and

Particularly, they are ordinal relations; i.e. they

• denotes strict preference;

•x ~f y and (not y ~f x) imply x p

• Completeness: For any two bundles x and

• Reflexivity: Any bundle x is always

• Take a reference bundle x’. The set of all

All bundles in I2 are

• When more of a commodity is always

• If less of a commodity is always

• A bundle strictly preferred to any

• A commodity is infinitely divisible if it can

• Suppose commodity 2 is an infinitely

• A preference relation is “well-behaved” if

• Convexity: Mixtures of bundles are (at

x2+y2 x+y is strictly preferred

x2 x when all mixtures z

Preferences are weakly

• The slope of an indifference curve is

MRS = - 0.5 Good 1

x2 MRS is not always increasing as

A consumption choice set

• A consumption bundle containing x1 units

• Commodity prices are p1, p2, … , pn.

• Q: When is a consumption bundle

• Q: When is a bundle (x1, … , xn) affordable

• The bundles that are only just affordable form the

• The consumer’s budget set is the set of all

• If n = 3 what do the budget constraint

• For n = 2 and x1 on the horizontal axis, the constraint’s

• For n = 2 and x1 on the horizontal axis, the

• The budget constraint and budget set

x2 New affordable consumption

• Increases in income m shift the constraint

• Increases in income m shift the constraint outward

• No original choice is lost and new choices

• What happens if just one price

Original m/p1’ m/p1”

• Reducing the price of one commodity

• Similarly, increasing one price pivots

• An ad valorem sales tax levied at a rate of

• A uniform sales tax levied at rate t changes

• A uniform sales tax levied at rate t changes the

• Food stamps are coupons that can be

• Suppose m = $100, pF = $1 and the price

G F + G = 100: before stamps.

G F + G = 100: before stamps.

• What if food stamps can be traded on

F + G = 100: before stamps.

• “Numeraire” means “unit of account”.

• If prices and income are measured in cents,

• The constraint for p1=2, p2=3, m=12

• Any commodity can be chosen as the