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**Hicksian Demand Functions, Expenditure Functions & Shephard’s Lemma
**

Consider a world with 2 goods (x and y), where Wilbur has well-defined preferences over bundles of those two goods, and those preferences can be represented by the utility function . Wilbur has income m and faces the parametric prices px and py. So Wilbur chooses the bundle that max s.t. .

Consider Wilbur’s Hicksian (conditional) demand functions for x and y.

where xh is the amount of x Wilbur would purchase to achieve utility level u given the prices px and py. The problem is min wrt to x and y s.t. The solution is that x and y that

min the cost of producing u utility given preference and the prices px and py

Hicksian Demand Functions, Expenditure Functions & Shephard’s Lemma

Edward R. Morey Feb 20, 2002

Morey Feb 20. is the cost function to produce u given px and py. 2002 .2 So. Expenditure Functions & Shephard’s Lemma Edward R. What would one get if one plugged ? and into the expenditure level / the minimum expenditures required to produce u given px and py. Hicksian Demand Functions. Hicksian demand functions are the solution to a cost minimum problem. That is. We call it the expenditure function It identifies minimum expenditure to produce u as a function of px and py.

3. Homogenous of degree one in p. That is. Nondecreasing in p. Concave in p. 2002 . That is. Morey Feb 20. Expenditure Functions & Shephard’s Lemma Edward R. for . That is. Hicksian Demand Functions. if then where . is continuous as a function of p for . 4. The expenditure function has the same properties as the cost function. That is. for .3 Properties of the expenditure function 1. . 2. Continuous in p.

Hicksian Demand Functions. 2002 . e. the “substitution effect” is not positive. Morey Feb 20. By Shepard’s Lemma . Expenditure Functions & Shephard’s Lemma Edward R. by Shepard’s Lemma (by concavity) That is.4 Since it has all the properties of a cost function (for producing u using the goods x and y) Shephard’s Lemma applies and and This gives us a very simple and straightforward way of deriving the Hicksian demand function. if derive the Hicksian demand functions. And by analogy . Can you prove Hicksian demand functions do not slope up if if non 9 in p. but not necessarily strictly negative.g. and concave in p and twice differentiable? Yes.

2002 . identifies maximum utility as a function of income and prices. is called the indirect utility function. as a function of prices.5 Duality between and and That is. p. What would you get if you solved for u? from Name this inverse function v. E. derive the direct utility function from the expenditure function (and vice versa) How? The same way we derived the production function using Shepard’s Lemma. Morey Feb 20. we can. Hicksian Demand Functions. identifies maximum utility. so . in theory. Expenditure Functions & Shephard’s Lemma Edward R. u. and the level of expenditures. If one sets the level of expenditures equal to income. m .

6 can be shown to have the following properties: 1) 2) . Expenditure Functions & Shephard’s Lemma Edward R. is a convex set for all k. Morey Feb 20. That is. That is. then . if is homogenous of degree zero in . is continuous . . 2002 . is nonincreasing in p. That is. for Hicksian Demand Functions. 3) 4) is quasiconvex in p.

We will soon prove Roy’s Identity. Note that the demand function is sometimes referred to as the Marshallian demand function. 2002 . What is the difference between the Marshallian demand function and the Hicksian demand function ? Hicksian Demand Functions.7 Looking ahead one can show that where is the demand function for good i. This result is know as Roy’s Identity. Morey Feb 20. Expenditure Functions & Shephard’s Lemma Edward R.

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