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Why is it usually required that utility function be concave? Is it because concavity is a necessary (or sufficient?) assumption for a unique equilibrium?

Can someone please spell this out for me? Thank you. Edit: To clarify, I'm interested in the mathematical (modeling) reason for concavity. That concavity implies diminishing marginal utility and risk aversion is another matter.

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    $\begingroup$ In contexts with uncertainty, you can also connect concavity to risk aversion. $\endgroup$
    – Bayesian
    Aug 1 at 19:28
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    $\begingroup$ I feel for me 'concavity' captures the spirit of a trade-off in economics. But yes, in terms of modelling, concave programming ensures a maximum. $\endgroup$
    – EB3112
    Aug 1 at 20:41
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    $\begingroup$ I've taken the liberty of editing the title of your question to reflect what I understand you are asking. Please feel free to reverse my edit if I've misunderstood. $\endgroup$ Aug 2 at 18:54
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More or less, yes.

Making the right assumption on the shape of the utility function allows you to prove existence or uniqueness of the equilibrium. The exact assumption you need depends on what exactly you are trying to prove and how general you want your result to be.

In the case of concavity, it also makes the equilibrium easier to find using the first-order conditions of the utility maximizer, because it makes sure that the local maximum that you find by setting the derivative of the Lagrangian to zero is also a global maximum.

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  • $\begingroup$ Thank you very much! $\endgroup$ Aug 1 at 15:14
  • $\begingroup$ You're welcome. Glad to be of help $\endgroup$
    – bbecon
    Aug 1 at 20:18
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    $\begingroup$ -1 This may be correct as an explanation of why it can be convenient to assume that utility functions are concave. But as an explanation of why concave utility functions are usually concave it is surely wrong - for that we need evidence from behaviour, eg of diminishing marginal rates of substitution. $\endgroup$ Aug 2 at 12:03
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    $\begingroup$ @OhadOsterreicher That's fine. In that case, this is indeed the correct answer. Could you update your original question above to make that a bit more clear (for future readers)? $\endgroup$
    – LBogaardt
    Aug 2 at 14:21
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    $\begingroup$ Yes my interpretation of the question was "what does the concavity assumption buy you in practice", (he asked "why is it REQUIRED", which makes me think of a mathematical condition rather than an empirical property). Of course, that is a distinct question from whether concavity is a good assumption in the first place. One problem I have with LBogaardt comment is that utility functions express the same preferences up to a monotonic transformation. Ex: U=sqrt(xy) expresses the same (convex) preferences as U=(xy)^2, but the first utility is concave the latter convex. bit.ly/3C7Nhmb $\endgroup$
    – bbecon
    Aug 2 at 19:16
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I disagree with @bbecon. I agree with @bbecon that concave utility functions present nice mathematical properties which help theorists develop analytical models.

If the OP's question was why utility functions are concave, the fundamental argument is that utility experiences diminishing returns.

Examine the image below, taken form here.

enter image description here

Let's say good X is coffee and good Y is cake. If you have 1 cup of coffee, getting a 2nd may increase your utility, but not by as much as the first one. Idem for 2 slices of cake. But if you could get 1 cup of coffee and 1 slice of cake, you would be most happy.

This argument fails under some special circumstances (e.g. this), but I think it's reasonable in most cases.

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    $\begingroup$ @crobar that article was rather lacking in logic and reasoning. I kept waiting for it to get better, figuring it must with the link text you used. But it didn't... $\endgroup$
    – Rick
    Aug 2 at 14:04
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    $\begingroup$ @crobar, I think by now Peters (2019) can be safely considered ignorable. I got this impression from the rebuttal by Doctor et al. (2019) and reactions elsewhere. Basically, it seems an enthusiastic physicist discovered economics and though he can fix it quickly and easily; not much of a surprise given https://xkcd.com/793/. Just as unsurprisingly, his idea happens to be neither original nor very influential as it misses the target. But I am open to other perspectives (preferably with references). $\endgroup$ Aug 2 at 15:07
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    $\begingroup$ @crobar, regarding Taleb, I have my reservations about his mastery of economics and finance. The fact that he refers to Peters (2019) just happens to make them stronger. $\endgroup$ Aug 2 at 15:11
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    $\begingroup$ @crobar, Peters' (and Meder et al.) work may be mathematically sound but it breaks in the applications to economic problems; some of his applications/examples are not valid, other not new. Try Doctor et al. (2019/2020) and especially their extended version / appendix (I have downloaded it but cannot find the source right now; should be possible to find from the paper itself) where all the details can be found. Perhaps your opinion of Peters (2019) will change after that. $\endgroup$ Aug 2 at 15:59
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    $\begingroup$ @crobar, I have opened a new thread to continue the debate on a meta level (not on the level of maths but rather reactions of respected economists and possible consensus in the profession). Consider opening another one if you would like to discuss Peters' critique on the "direct" (non-meta) level; I would be curious to see what the community thinks about it. $\endgroup$ Aug 3 at 7:13

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