Optimization in Economic Theory Second Edition BY AVINASH K. DIXIT OXFORD UNIVERSITY PRESSOsi University Press, Walton Street, Oxford OX? 6DP Ovfand New York Toronto Delhi Hombay Cuesta Madras Karachi Peraing Java Singapore Hone Kong Toke ‘Nairobi Dares Salaam Cape Town Meliowne Auetland and asselted companies ‘Berlin Inada Osford is atrade mark of Ovfrd University Press Pubiishd nthe United Stes nv Oxford University Press Ne York Avinash K Dit 1990 ie pabhisod 1990 aperivak eprnte (90, 1991 (38) Allright reserved opr of this publication maybe reproduced, stordindreticul yr orton, ams formor bans meas ‘lecinmt. mec lune phon, recondng orohereise, witha! ‘he prior pcan of Oxford Unversity Pree Tsk wl jee the canton that sal tb way oftrade on viernive hele, 2-0, red oat otheregeeratated ‘is te pubte's pe onset inform of nding cove? cenier thant stich ii publsher al witht asia condi Inlaid biped nt he subsequent purchase? Iii Library Celine in Pablication Data Dis Avinash, K Oprimicaion economic theory 1 Esonomies Opinion Tide 28001515 1SBNO-19-877211-4 ISBN 0-19-877210-6 (PAK) and, ibrar of Congres Cataloging in Publication Data Data no avalable Typeset by A. K. Dir using TEX Pet and Bound Groat Brainy Baas ta, ‘Gudford and King's Lon PREFACE ‘Making optimal use of scarce resources, that is, maximizing subject to constraints, is the central theme of economies. But students of ‘economics axe often taught the mathematies of constrained maxi- ‘ization as a branch of mathesuaties, and its economic applications follow separately. An integrated treatment that relates the math fematies to the economics from the beginning has the potential for providing a quicker and deeper understanding. This book aims to give such an exposition. Temphasize economic intuition rather than mathematical rigor. Proofs of the mathematical theorems are structured to bring out points of economic interest and facilitate economic applications. The illustrative examples and exercises are also chosen for their economic interest and usefulness. ‘The first edition of this book was published in 1976. The een- tral aim of the book is still valid, but the subject hins changed great deal over the years. Therefare I have revised the text very substantially. A chapter on uncertainty, with some treatment of topies like Snance and asymmetric information, is now indispens- able. [have added such a chapter, and have also expanded the chapter on dynamic programming to treat uncertainty. ‘Most chapters have been thoroughly rewritten, and many new examples and exercises added. One innovation deserves special mention. When the first edition was written, the main mode of ex- position in elementary and intermediate microeoonomnies was geo- metric, based on the tangency between a budget line and an indif- ference curve, oF a cost line and a production isoquant. Nowadays this shibboleth of tangeney seems lese prevalent. Thevefore I have used a starting-point that is simpler and economically space intu- itive, namely the search for costless improvements through ‘arbi- ‘rage’ operations. This allows an integrated treatment of tangency and comer optima, and its intuition extends much mote readily to situations involving time, uncertainty ete. In the years since the frst edition of this book was published, the mathematical training of economics students his improved sub- stantially. [have taken advantage of this by going a little deeper into some topics, letting the pace pick up in the last three chap- ters, and sketching the proof of the central result of constrained maximization the Kuhn Tucker theres ~ in a mathematical ap- pendix. But the book remains aimed at the majority of economiesvi Preface students in the last two years of undergraduate studies o the first year of graduate work, not the small minority who plan to become ‘uathematical economists, ‘The main use of the book is as a supplementary text inn crocconomies courses at the intermediate and advanced levels, Tt can be used as the main text, but should then be supplemented by fother books or articles, inchiding those listed for fusther reading at the end of each chapter. Short courses on consumer and pro- ducer behavior ean be based on chapters 1-8. Chapters 9 snd 10 are independent of each othe. Therefore courses that include op- timization over time but not uncertainty can omit chapter 9 and parts of 11. Conversely, those that include uncertainty but not time can omit chapters 10 and 11 ‘The examples ae fully solved out as far as the main line of reasoning is concerned, but some details are omitted. ‘The exer- ‘isos contain further development of the theory in the text, as well ‘as applications. The examples and exercises are an integral part of learning from the book, and I urge readers to work carefully through them. T thank many readers who gave me useful suggestions for im proving on the first edition, Among them, Pete Kyle deserves special mention, Tasn very grateful to Richard Quandt for reading the entize manuscript of the second edition with great eare and pointing out several errors, [also thank Barry Nalebuff and Carl Shapiro for reading several chapters. Peter Kenen’s Lav says that there is always at least one more typo than yor think, and I retain responsibility for the errors that rexnain. Princeton AKD. December 1989 CONTENTS 1. Introduction 2, Lasgrange’s Method 3, Extensions and Generalizations 4, Shadow Prices 5, Maximum Value Punetions 6. Convex Sets and Their Separation 7. Concave Programming 8. Second-Order Conditions 9. Uncertainty 10. Time: The Maxinum Principle IL. Dynamic Progeaaming Appendix ~ Kuhn-Tucker Theorera Index 10 4 40 35 69 86 105 122 M5 162 asl 187