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Hicksian Demand Functions,

Expenditure Functions & Shephards 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 Wilburs 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 & Shephards Lemma

Edward R. Morey Feb 20, 2002

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So, Hicksian demand functions are the solution to a cost minimum problem.

What would one get if one plugged

and

into the expenditure level

/ the minimum expenditures required to produce u given px and py.

That is,

is the cost function to produce u given px and py.

We call it the expenditure function

It identifies minimum expenditure to produce u as a function of px and py.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

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Properties of the expenditure function

where

1.

Nondecreasing in p. That is, if

then

2.

Homogenous of degree one in p. That is,

3.

Concave in p. That is,

for
.

4.

Continuous in p. That is,

.
.
for

is continuous as a function of p for

The expenditure function has the same properties as the cost function.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

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Since it has all the properties of a cost function (for producing u using the goods x and y) Shephards
Lemma applies and

and

This gives us a very simple and straightforward way of deriving the Hicksian demand function.
e.g. if

derive the Hicksian demand functions.

By Shepards Lemma
.
And by analogy
.
Can you prove Hicksian demand functions do not slope up if
if non 9 in p, and concave in p and twice differentiable?
Yes, by Shepards Lemma
(by concavity)

That is, the substitution effect is not positive, but not necessarily strictly negative.
Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

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Duality between

and

and
That is, we can, in theory, derive the direct utility function from the expenditure function (and vice
versa)
How?
The same way we derived the production function

from

using Shepards Lemma.

What would you get if you solved

for u?

Name this inverse function v, so

.
identifies maximum utility, u, as a function of prices, p, and the level of expenditures, E.
If one sets the level of expenditures equal to income, m
.
identifies maximum utility as a function of income and prices.
is called the indirect utility function.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

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can be shown to have the following properties:
1)

is nonincreasing in p. That is, if

, then

2)

is homogenous of degree zero in

. That is,

for

.
3)

is quasiconvex in p. That is,

4)

is continuous

is a convex set for all k.

.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

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Looking ahead one can show that

where
is the demand function for good i.
This result is know as Roys Identity. We will soon prove Roys Identity.
Note that the demand function

is sometimes referred to as the Marshallian demand function.

What is the difference between the Marshallian demand function

and
the Hicksian demand function
?

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002