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E CON 125: M ICROECONOMIC T HEORY

L ECTURE 1: P REFERENCES AND U TILITY

Consider a set of possible alternatives X from which an agent will make a choice. This set may
be finite or infinite. The leading example to keep in mind is consumption choice, where the agent
chooses a consumption bundle in an economy with n goods, so that X D RnC , the nonnegative
orthant of Rn . But for todays lecture we will deliberately keep the setting abstract.

Definition 1. A preference on a set X is a binary relation % on X satisfying the following two


axioms:1

(a) Completeness: for all x, y 2 X , either x % y or y % x.

(b) Transitivity: for all x, y, z 2 X , if x % y and y % z, then x % z.

Given a preference % on X , we define another binary relation  on X, called the strict preference,
as follows: x  y if x % y holds and y % x does not hold; we also define the indifference relation
 on X: x  y if x % y and y % x.

Examples:

(a) The order > on R is complete and transitive.

(b) The inclusion order  on sets is not complete. However, it is transitive.

(c) Consider the lexicographic order %L on Rn : for all x, y 2 Rn , we define x %L y if either


of the following conditions hold:

(i) xi D yi for all i D 1; : : : ; n


(ii) x1 > y1
(iii) there is some m 2 f2; : : : ; ng such that xm > ym and xi D yi for all 1 6 i 6 m 1.

The lexicographic preference is complete and transitive. (Show it as an exercise.)

Why might preferences be incomplete? This can arise when a person is unable to choose but
is not indifferent. Examples are anything where the agent is unable to distinguish characteristics
of alternatives but if she could she would have a preference.
When might transitivity fail? Suppose a three member household is making a decision based
on a majority of opinions. This aggregation process can yield intransitivities (this is known as the
Condorcet paradox). For example, if the three members rank the alternatives as x 1 y 1 z,

1A binary relation on a set X is simply a subset of the Cartesian product X  X.

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y 2 z 2 x, and z 3 x 3 y, then the majority rule adopted by the household determines x to
be preferred over y, y over z, and z over x, thus violating transitivity.
The following proposition summarizes important implications of the definition above.

Proposition 1. Let % be a preference on a set X . Then:

(a) 8x; y 2 X , either x  y, or y  x or x  y.

(b)  is transitive and irreflexive (8x 2 X, x x).

(c)  is reflexive (8x 2 X , x  x), transitive and symmetric (8x, y 2 X , x  y iff y  x).

(d) The following mixed form of transitivity holds: 8x; y; z 2 X, x  y and y  z imply
x  z.

Proving the proposition is a great exercise to practice the manipulation of the completeness
and transitivity axioms.
A utility function on a set X is a real-valued function defined on X.

Definition 2. A utility function U W X ! R represents a preference relation % on X if 8x, y 2 X,


x % y U.x/ > U.y/.

It should be clear that a utility function induces a preference relation. The interesting question
is whether the converse is true. This is important because preferences are regarded as a primitive
for the decision maker, not the utility function. In fact, as far as behavioral implications are con-
cerned, utility numbers have no intrinsic meaning: there are infinitely many utility representations
of any given preference.

Proposition 2. If U W X ! R represents % then, for any strictly increasing function f W R ! R,


the composite function f U also represents %.

Proof. x % y U.x/ > U.y/ f .U.x// > f .U.y// (since f is strictly increasing). 

We first show that preferences on finite sets have utility representations.

Proposition 3. Every preference relation on a finite set X has a utility representation.

Proof. As the set is finite, we can rank all the elements of X in increasing order of preference,
possibly with ties. (Can you give a formal proof of this statement by induction on the size of
the set X?) We then define a utility function on X as follows. The worst preferred elements
(that is, those that are not strictly preferred to any other element), get utility 1. Then, the worst
preferred elements among the remaining elements get utility 2, and so on. By construction, the
utility function represents the preference. 

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The construction of a utility function that represents a preference % gets a bit more complicated
when X is countably inifinite, since such sets need not have minimal elements. (Can you think of
an example of a preference on a countable set with no minimal element?) Nonetheless:

Proposition 4. Every preference relation on a countable set X can be represented by a bounded


utility function.

Proof. Fix an arbitrary enumeration X D fx 1 ; x 2 ; : : : ; x ` ; : : : g and define a utility function U W


X ! 0; 1/ as follows: for each ` 2 N, U.x ` / D 0 if there is no x k 2 X with x `  x k ; otherwise,
define  k
`
X 1
U.x / D :
` k
2
k2N W x x

Then, if x `  x j we must have U.x ` / D U.x j /, as the two summations range over the same
set of indices. Moreover, if x `  x j we have must have U.x ` / > U.x j /, as the set of indices
corresponding to the summation in U.x ` / must contain the set of indices corresponding to the
summation in U.x j / as a proper subset. (This follows from the transitivity and irreflexivity of the
strict preference relation.) 

Does a preference relation on an uncountable set (such as RnC as in consumption choice)


always have a representation? Not without an additional condition.

Proposition 5. The lexicographic preference relation %L on R2 does not have a utility represen-
tation.

Proof. Assume by contradiction that a utility function U represents %L . For any x 2 R, we


have .x; 1/  .x; 0/ and thus U.x; 1/ > U.x; 0/. Select a rational number q.x/ in the nonempty
interval Ix WD .U.x; 0/; U.x; 1//. Then, the function x 7! q.x/ is a one-to-one function from R
into the set of rational numbers Q, since x > y implies U.x; 0/ > U.y; 1/, so that the intervals
Ix and Iy are disjoint. But Q is countable, whereas R has the cardinality of the continuum, hence
there cannot be a one-to-one function mapping R into Q. 

As we will see below, the problem with the lexicographic preference is that it displays
sudden preference reversals. For example, consider the lexicographic preference in R2 and pick
an arbitrarily small but positive number " > 0. Then, ."; 0/ is strictly preferred to .0; 1/ no matter
how small " is. But when " D 0, we suddenly have .0; 1/ strictly preferred to ."; 0/! The following
axiom rules out such sudden preference reversals.

Definition 3. A preference relation % on X  Rn is continuous if the set f.x; y/ 2 X X j x % yg


is a closed set relative to X  X: for every pair .x k /k2N , .y k /k2N of convergent sequences in X
such that x k % y k for all k 2 N, we must have lim x k % lim y k .

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In words, if we have sequences x k and y k (k D 1; 2; : : : ;) in X such that along the sequence
we always have x k weakly preferred to y k , and moreover x k and y k are approaching x and y,
respectively, as k ! 1, then the axiom of continuity requires that x remains weakly preferred to
y.
The following result characterization provides an equivalent way to think about continuity:

Proposition 6. The following statements concerning a preference relation % on X are equivalent:

(a) % is continuous;

(b) 8x 2 X the upper contour set % .x/ D fy 2 X W y % xg and the lower contour set
- .x/ D fy 2 X j x % yg are closed in X .

One direction of the result is straightforward, namely that (a) implies (b). (Think about it!)
The converse is a bit more complicated. I leave this as an exercise for those of you who are more
technically inclined.
As mentioned above, lexicographic preferences are not continuous: .1=k; 0/ belongs to the
upper contour set UL .0; 1/ for all k 2 N, .1=k; 0/ ! .0; 0/, but .0; 0/ does not belong to
UL .0; 1/. (The element .0; 0/ lies on the boundary of the upper contour set UL .0; 1/, but does
not belong to it.) Here is a picture to illustrate:
[FIGURE TO BE INSERTED]
If we deal with continuous preferences on sufficiently well-behaved spaces X, we get a
positive result. The following theorem, due to Gerard Debreu, is a cornerstone of the foundations
of microeconomics.

Theorem 1 (Debreu). Assume that X is a connected subset of an Euclidean space. Then every
continuous preference relation on X has a continuous utility representation.

Most of you have probably not seen the definition of a connected set in your math courses
(unless you have taken some version of real analysis). But do not worry, it is not terribly impor-
tant: the application we care the most about is that of consumption choice, where the space of
alternatives X is the nonnegative orthant of an Euclidean space, which is connected. In any case,
if you are curious about the definition, here it is: a set X is disconnected if it can be written as the
disjoint union of two nonempty subsets of X, each of which is closed in X ; a set is connected if it
is not disconnected.
[FIGURE TO BE INSERTED]

Readings: Jehle and Reny, Chapter 1, pp.38 (up to Axiom 3).