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Duality

Advanced Microeconomics

Consumer theory: optimization and duality

Jan Hagemejer

Introduction

The consumer problem Introduction

Duality

Introduction

The plan:

2 The expenditure minimization

3 Duality of the consumer problem

4 Some examples

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

or: choose a bundle x y for x and any y 's in the budget set B ,

given prices p and wealth w

or: if we have a utility function representing , maximize utility

subject to the budget constraint (given by p and w ).

the correspondence between prices p , wealth w and the consumer

chosen bundle is the demand correspondence.

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

locally nonsatiated preference relation.

preferences

The utility maximization problem is dened as:

Maxx 0 u (x )

subject to px w

If u (x ) is well behaved, then this problem has a solution x (p, w )

which is the so-called Walrasian demand correspondence

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

L = u (x ) (p x w )

u (x )

x1 p1 0

. u (x )

.

= ppl

x

.

u (x )

which gives (if interior solution) l

u (x ) for all l, k

pL 0 x k

k

xL

px w 0

and hence: MRSlk = ppkl

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

L

u (x )

du = 0 =

X

xl

l =1

Lets assume that dxl 6= 0 and dxk 6= 0 and all other dxn = 0:

u (x ) u (x )

0 = dxl + dxk

xl xk

Rearrange:

u (x )

dxl xl

= = MRSlk

dxk u (x )

xk

to give away l for k is equal to the ratio of prices.

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

The UMP

binding (which is usually the case).

u (x )

satisied with inequality, i.e.

xl < pL (corner solution)

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

need to set up the full Kuhn-Tucker problem with:

Pl

The budget constraint l =1 pl xl w with the Lagrange multiplier

0

L inequality constraints xl 0 with the L Lagrange multipilers l

l l

L = u (x ) 0 ( p l xl w ) + l (xl )

X X

l =1 l =1

(l >0 and xl = 0). You have to check all the combinations!

PL

Example: For the utility function u (x ) = l =1 al xl , l = 2, nd the

demand function.

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

l l

L = a1 x1 + a2 x2 0 ( pl xl w ) + l (xl )

X X

l =1 l =1

FOC's are:

[x1 ] a1 0 p1 + 1 = 0

[x2 ] a2 0 p2 + 2 = 0

[0 ] p1 x1 + p2 x2 w 0, 0, (w p1 x1 p2 x2 ) = 0,

[1 ] x1 0, 1 0, 1 x1 = 0

[2 ] x2 0, 2 0, 2 x2 = 0

Case 1: 0 > 0, and all l = 0, therefore all xl > 0 (interior solution)

a a

from rst 2 FOCs we have: 1 = 0 and 2 = 0 1 / 1 = 2 / 2 or

p1 p2 a p a p

p1 a1 a1 a2

p2 = a2 or better p1 = p2 (the expenditures on one unit of MU are

equal).

All other cases are corner solutions.

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Case 2:

The FOC's become:

a2 0 p2 = 0 and a1 0 p1 + 1 = 0 pa11 = 0 p11 < 0 = pa22 , so

a1 a2

p1 < p2

Case 3:

The FOC's become:

a1 0 p1 = 0 and a2 0 p2 + 2 = 0 pa22 = 0 p22 < 0 = pa11 , so

a2 a1

p2 < p1

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

x1 = p1 , x2 = 0.

w a1 a2

if

p1 > p2

x (p) = x1 , x2 : p1 x1 + p2 x2 = w if

p1 a1

p2 = a2

x2 = pw2 , x1 = 0 if

a1 a2

p1 < p2

As long as the bang for the buck is equal, we have the interior solution,

otherwise only corner solutions.

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

consumption bundles for each price-wealth pair (p , w )

It can be multi-valued. If single valued we call it a demand function

Walrasian demand correspondence possesses the following properties:

2 Walras law: px =w (the budget constraint is binding)

3 Convexity/uniqueness: if is convex, so that u () is quasiconcave,

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Wealth eects given the vector of prices p on the demand for good

xl (p ,w )

l , partial derivative: w .

In matrix notation:

x1 (p ,w )

w

.

.

.

Dw x (p, w ) = xl (p ,w )

w

.

.

.

xL (p ,w )

w

xl (p ,w )

w > 0, good is normal, if all > 0 then demand is normal

xl (p ,w )

w < 0, good is inferior.

Demand as a function of wealth x (p w

, ), Engel function

Wealth expansion path: Ep = {x (p, w ) : w > 0}

Income elasticity of demand: w = x(pw,w ) x (pw,w ) , necessity <1,

luxury >1

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Wealth eects

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Price eects

xl (p ,w )

The price eect is dened as:

pk and usually > 0. If <0 then

In matrix notation

x1 (p ,w ) x1 (p ,w )

p1 pL

Dp x (p, w ) = . ..

. .

.

xL (p ,w ) xL (p ,w )

p1 ... pL

xl (p ,w ) pl xl (p ,w ) pl

demand

pl xl (p ,w ) and pk xk (p ,w ) where k 6= l

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Oer curve

OC - a locus of points demanded in over all possible values of one of the

prices (in R2 ).

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Once we have the optimal choice, x (p, w ) we can plug it back into

the utility function.

it says what the level of utility is, given prices and wealth and utility

maximization

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

What for?

levels of prices that generate and utility at xed prices

same utility given wealth

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Expenditure minimization

Instead of UMP, let us think of the consumer that has a desired level

of utility.

expenditure.

obvious

minx 0 px subject to u (x ) u

The solution is h(p, u ), the demand for goods given prices and

utility, the so called Hicksian demand (contrast it to x (p, w )).

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Once we have the solution to the problem, we can calculate the actual

expenditure:

L

e (p , u ) = pl h(p, u )

X

l =1

prices.

Why is it useful?

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Expenditure minimization

Introduction The UMP

The consumer problem Walrasian demand

Duality The EMP

Introduction

The consumer problem

Duality

2 x (p, e (p, u )) = h(p, u )

3 e (p, v (p, w )) = w

4 v (p, e (p, u )) = u

Introduction

The consumer problem

Duality

h (p , u ) = p e (p , u )

1

x (p , w ) = p v (p , w )

w v (p , w )

Introduction

The consumer problem

Duality

nonsatiated and strictly convex preference relation dened on the

consumption set X = RL+ . Then for all (p , w ), and u = v (p, w ), we have

hl ( p , u ) xl (p , w ) xl (p , w )

= + xk (p, w )

pk pk w

hl (p , u ) xl ( p , w ) x (p , w )

xk ( p , w ) = l

p w pk

| {zk } | {z }

Substitution eect Income eect

Introduction

The consumer problem

Duality

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