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2011 Micro Lecture2 PDF
2011 Micro Lecture2 PDF
Advanced Microeconomics
Consumer theory: optimization and duality
Jan Hagemejer
Introduction
The plan:
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.
Maxx ≥0 u (x )
subject to p·x ≤w
If u (x ) is well behaved, then this problem has a solution x (p, w )
which is the so-called Walrasian demand correspondence
L = u (x ) − λ(p · x − w )
∂ u (x )
∂ x1 − λp1 ≤ 0
. ∂ u (x )
.
= ppl
∂x
.
∂ u (x )
which gives (if interior solution) l
∂ u (x ) for all l, k
− λpL ≤ 0 ∂x k
k
∂ xL
p·x −w ≤0
and hence: MRSlk = ppkl
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
The UMP
l =1 l =1
l l
L = a1 x1 + a2 x2 − λ0 ( pl xl − w ) + λl (xl )
X X
l =1 l =1
FOC's are:
[x1 ] a1 − λ0 p1 + λ1 = 0
[x2 ] a2 − λ0 p2 + λ2 = 0
[λ0 ] p1 x1 + p2 x2 − w ≤ 0, λ ≥ 0, λ(w − p1 x1 − p2 x2 ) = 0,
[λ1 ] x1 ≥ 0, λ1 ≥ 0, λ1 x1 = 0
[λ2 ] x2 ≥ 0, λ2 ≥ 0, λ2 x2 = 0
Case 1: λ0 > 0, and all λl = 0, therefore all xl > 0 (interior solution)
a a
from rst 2 FOCs we have: 1 = λ0 and 2 = λ0 → 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).
Case 2:
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.
luxury >1
Wealth eects
Price eects
In matrix notation
∂ x1 (p ,w ) ∂ x1 (p ,w )
∂ p1 ∂ pL
Dp x (p, w ) = . ..
. .
.
∂ xL (p ,w ) ∂ xL (p ,w )
∂ p1 ... ∂ pL
Oer curve
OC - a locus of points demanded in over all possible values of one of the
prices (in R2 ).
Once we have the optimal choice, x (p, w ) we can plug it back into
the utility function.
What for?
Expenditure minimization
Instead of UMP, let us think of the consumer that has a desired level
of utility.
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 )).
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
Why is it useful?
Expenditure minimization
h (p , u ) = ∇ p e (p , u )
1
x (p , w ) = − ∇ p v (p , w )
∇w v (p , w )
∂ hl (p , u ) ∂ xl ( p , w ) ∂ x (p , w )
− xk ( p , w ) = l
∂p ∂w ∂ pk
| {zk } | {z }
Substitution eect Income eect
Recap