De La Salle University

School of Economics
MIC1ECO
Term 1, AY 2021 - 2022
Dr. Angelo A. Unite
Assignment 3: Demand Functions, Indirect Utility Function and Expenditure Function

1. This assignment is a group effort (minimum of 1 student and maximum of 2 students per group), and thus, there
should only be one set of solutions per group. You are not allowed to consult with nor be consulted by other students
currently enrolled in this group. A FINAL GRADE OF 0.0 WILL BE GIVEN TO THE STUDENTS WHOSE
REPORTS ARE PROVEN TO BE COPIES (IN FULL OR IN PART) OF EACH OTHER.
2. For each main problem (indicated by a Roman numeral), answer the sub-questions (indicated by an Arabic numeral)
in their order of appearance. Start answering each main problem (indicated by a roman numeral) in a new sheet. For
each main problem, be sure to indicate the number of the sub- question you are answering. Read the questions
carefully and answer only what is required. Do not make any assumptions other than those given in the problems.
3. Be sure to show the theoretical justification or basis for your answers to each question in this exam. You should start
each answer with a brief discussion of the basis for your answer. The basis is usually an economic concept, a
mathematical definition, or a set of conditions that provides the framework for your answer. Do not just turn in
computations! No explanation and basis, no credit.
4. Simplify all final answers. For final answers that involve numerical values, round off to the nearest 4 decimal places.
5. For questions that require you to determine the sign of derivatives or mathematical functions, be sure to show the
basis for the sign.
6. Your answers should be word processed (MSWord or Pages) on A4-size document with 1-inch margins all around.
You can generate equations using MathType or MS Word’s build-in Equation Editor. See the pdf document “Guides
to Using MathType” for the instructions on how to use MathType in MS Word or Pages. Graphs can be generated
using Mathematica, MSWord, or MSExcel.
7. Avoid using Google Docs as it sometimes destroys formatting and/or equations when exporting to PDF. Microsoft
Word allows real-time collaborative editing (follow this link for a tutorial https://bit.ly/CollabinMSWord).
8. NO SECTION OF YOUR ASSIGNMENT MAY BE HANDWRITTEN OR IN THE FORM OF SCANNED IMAGES.
Submissions with handwritten or scanned answers (in part or in full) will not be given any credit. Answers involving
equations that were not generated using MS Equation Editor or MathType will not be given any credit.
9. Type, sign and date the Pledge of Academic Honesty Pledge below and make it the cover page of your report.

Pledge of Academic Honesty

This is to certify that we did not consult with anyone, including copying the answered assignments of students who
took this course in previous trimesters, in arriving at our answers to this assignment in MIC1ECO. In addition, we
are certifying that we did not allow ourselves to be consulted by other students who are currently enrolled in this
course during their solving the same assignment. We are aware that a final grade of 0.0 will be given to the students
whose reports are confirmed to be copies (full or partial) of each other and students who violated this pledge.

__________________________________________________
Signature over printed name and date – Group Member 1

__________________________________________________
Signature over printed name and date – Group Member 2

10. Save your Word document in PDF file format. The pdf file should be uploaded in Canvas. Be sure that your signature
is on the pledge of academic honesty. No signature/s, no credit.
11. The Canvas facility for uploading of the pdf copy of your word-processed answers closes at 8:00 am of the last day of
submission specified in this syllabus (SCHEDULE OF ASSIGNMENTS). Submissions made outside the Canvas
Assignment facility will not be accepted nor given any credit.
12. Any correction on the mark for this assignment must be brought up with my teaching assistant during the week when
the marked version of this assignment is returned to the students. After this one-week period, any correction on the
mark shall no longer be considered.
13. Any student may be asked to present and discuss his/her group’s solutions in class. The schedule of oral presentation
of answers to the assignments is given in the Learning Plan.
For both Problems I and II, 𝒙𝟏 is the quantity of good 1, 𝒙𝟐 is the quantity of good 2, 𝒑𝟏 is the price of
good 1, 𝒑𝟐 is the price of good 2, and m is the nominal income. All prices and income are positive
exogenous variables.

START ANSWERING PROBLEM I IN A NEW SHEET

I. You spend your entire income on two goods, good 1 and good 2. Your preferences are represented by
the utility function 𝑼 = 𝟐𝒙𝟏 + 𝟒𝒙𝟎𝟐.𝟓 for 𝒙𝟏 > 𝟎 and 𝒙𝟐 > 𝟎.
1. Using the necessary conditions and the above information, write the two first-order conditions
that your choice of 𝒙𝟏 and 𝒙𝟐 must satisfy to maximize your utility. (Note: You are not being asked
to solve for 𝒙𝟐 and 𝒙𝟐 in this question.)
2. Use your results in part 1 to find your Marshallian demand functions for the two goods. Simplify
your answers. You do not need to show that the SOC for a maximum utility is satisfied.
3. What values of 𝒑𝟏 will ensure that the quantity demand of good 1 is positive?
4. Let t be the proportion change in all prices and income. Demonstrate that your Marshallian
demand functions for the two goods are homogeneous of degree 0 in prices and income.
5. Is good 1 normal or inferior? How about good 2? Show the basis for your answer.
6. Find your indirect utility function. Simplify your answer.
7. Find you expenditure function. Show and briefly discuss how you arrived at your answer.
8. Use Shephard’s Lemma to find your Hicksian demand functions for the two goods.

START ANSWERING PROBLEM II IN A NEW SHEET

II. You consume only two goods, good 1 and good 2. Your utility function is given by 𝑼 =
𝒎𝒊𝒏{𝟑𝒙𝟏, 𝟔𝒙𝟐}.

1. Using the necessary conditions and the above information, write the two first-order conditions
that your choice of 𝒙𝟏 and 𝒙𝟐 must satisfy to maximize your utility. (Note: You are not being asked
to solve for 𝒙𝟐 and 𝒙𝟐 in this question.)
2. Use your results in part 1 to find your Marshallian demand functions for the two goods. Simplify
your answers. You do not have to show that the SOC for a maximum utility is satisfied.
3. Let t be the proportion change in all prices and income. Demonstrate that your Marshallian
demand functions for the two goods are homogeneous of degree 0 in prices and income.
4. Is good 1 normal or inferior? How about good 2? Show the basis for your answer.
5. Find your indirect utility function. Simplify your answer.
6. Find your expenditure function. Show and briefly discuss how you arrived at your answer.
7. Use Shephard’s Lemma to find your Hicksian demand functions for the two goods.
I. You consume only two goods, good 1 and good 2. Your utility function is given by 𝑼 =
𝒎𝒊𝒏{𝟑𝒙𝟏, 𝟔𝒙𝟐}.

1. Using the necessary conditions and the above information, write the two first-order
conditions that your choice of 𝒙𝟏 and 𝒙𝟐 must satisfy to maximize your utility.
(Note: You are not being asked to solve for 𝒙𝟐 and 𝒙𝟐 in this question.)

The budget optimization is used to maximized utility, with a given fixed nominal income, and
prices of goods. It is either solved graphically or mathematically, with the aid of calculus.
The mathematical approach requires certain conditions that the utility functions must meet.
(i). Utility function must be at least, twice differentiable,
(ii). and at least one of the Second Order Partial Derivatives is non-zero.

With the given conditions, 𝑼 = 𝒎𝒊𝒏{𝟑𝒙𝟏 , 𝟔𝒙𝟐 }, 𝒎, 𝒑𝟏 , 𝒑𝟐 > 𝟎 cannot be applied using the
mathematical approach. As the utility function 𝒎𝒊𝒏{𝟑𝒙𝟏 , 𝟔𝒙𝟐 } is not differentiable. Hence,
the two conditions that must be satisfied by the satisfied by the utility maximizing
consumption bundle 𝒙𝟏 and 𝒙𝟐 are;
(i). The optimal quantities demanded will be at the vortex of an indifference curve
where; 𝜶𝒙𝟏 = 𝜷𝒙𝟐, and
(ii). The optimal quantities must also lie along the consumer’s budget line where;
𝒎 = 𝒑𝟏 𝒙𝟏 + 𝒑𝟐 𝒙𝟐 .

2. Use your results in part 1 to find your Marshallian demand functions for the two
goods. Simplify your answers. You do not have to show that the SOC for a
maximum utility is satisfied.

The Marshallian demand function shows the utility maximizing bundle 𝒙𝟏 and 𝒙𝟐 , ∀ 𝒙𝟏 >
𝟎, 𝒂𝒏𝒅 𝒙𝟐 > 𝟎 with prices and nominal income given.

From number 1, 𝑼 = 𝒎𝒊𝒏{𝟑𝒙𝟏 , 𝟔𝒙𝟐 }, 𝒎, 𝒑𝟏 , 𝒑𝟐 > 𝟎, can be written using the two conditions
mentioned.

(i). 𝜶𝒙𝟏 = 𝜷𝒙𝟐,

𝟑𝒙𝟏 = 𝟔𝒙𝟐 𝟑𝒙𝟏 = 𝟔𝒙𝟐
𝟑𝒙𝟏 𝟔𝒙𝟐 𝟑𝒙𝟏 𝟔𝒙𝟐
= =
𝟑 𝟑 𝟔 𝟔
𝟑𝒙𝟏
𝒙𝟏 = 𝟐𝒙𝟐 = 𝒙𝟐
𝟔
𝒙𝟏
= 𝒙𝟐
𝟐
(ii). 𝒎 = 𝒑𝟏 𝒙𝟏 + 𝒑𝟐 𝒙𝟐 . We are to substitute 𝒙𝟏 and 𝒙𝟐 .

𝒙
𝒎 = 𝒑𝟏 (𝟐𝒙𝟐 ) + 𝒑𝟐 𝒙𝟐 𝒎 = 𝒑𝟏 𝒙𝟏 + 𝒑𝟐 ( 𝟐𝟏 )
𝟏
𝒎 = 𝒙𝟐 (𝟐𝒑𝟏 + 𝒑𝟐 ) 𝒎 = 𝒙𝟏 (𝒑𝟏 + 𝟐 𝒑𝟐 )
𝟏
𝒎 𝒙𝟐 (𝟐𝒑𝟏 +𝒑𝟐 ) 𝒎 𝒙𝟏 (𝒑𝟏 +𝟐𝒑𝟐 )
= 𝟏 = 𝟏
(𝟐𝒑𝟏 +𝒑𝟐 ) (𝟐𝒑𝟏 +𝒑𝟐 ) (𝒑𝟏 +𝟐𝒑𝟐 ) (𝒑𝟏 +𝟐𝒑𝟐 )

𝒎 𝟐𝒎
= 𝒙𝟐 ∗ for 𝒎 > 𝟎, 𝒑𝟏 > 𝟎, 𝒑𝟐 > 𝟎 (𝟐𝒑𝟏 +𝒑𝟐 )
= 𝒙𝟏 ∗ for 𝒎 > 𝟎, 𝒑𝟏 > 𝟎, 𝒑𝟐 > 𝟎
(𝟐𝒑𝟏 +𝒑𝟐 )

3. Let t be the proportion change in all prices and income. Demonstrate that your
Marshallian demand functions for the two goods are homogeneous of degree 0 in
prices and income.

Demand functions are homogenous of degree zero in prices and nominal income, that is; if all
prices and income change by the same proportion 𝒕 > 𝟎, the quantities demanded remain
unchanged.
𝒙𝒊 (𝒕𝒑𝟏 , 𝒕𝒑𝟐 , 𝒕𝒎) = 𝒙𝒊 (𝒑𝟏 , 𝒑𝟐 , 𝒎)

𝟐𝒎 𝒎
From number 2: 𝒙𝟏 ∗ = , 𝒙𝟐 ∗ =
(𝟐𝒑𝟏 +𝒑𝟐 ) (𝟐𝒑𝟏 +𝒑𝟐 )

𝒕(𝟐𝒎) 𝒕(𝟐𝒎) 𝟐𝒎
𝒙𝟏 ∗ (𝒕𝒑𝟏 , 𝒕𝒑𝟐 , 𝒕𝒎) = = = (𝟐𝒑 = 𝒙𝟏 ∗ (𝒑𝟏 , 𝒑𝟐 , 𝒎)
𝒕(𝟐𝒑𝟏 )+𝒕𝒑𝟐 𝒕(𝟐𝒑𝟏 +𝒑𝟐 ) 𝟏 +𝒑𝟐 )

𝒕𝒎 𝒕(𝒎) 𝒎
𝒙𝟐 ∗ (𝒕𝒑𝟏 , 𝒕𝒑𝟐 , 𝒕𝒎) = = = (𝟐𝒑 = 𝒙𝟐 ∗ (𝒑𝟏 , 𝒑𝟐 , 𝒎)
𝒕(𝟐𝒑𝟏 )+𝒕𝒑𝟐 𝒕(𝟐𝒑𝟏 +𝒑𝟐 ) 𝟏 +𝒑𝟐 )

Since 𝒙𝒊 (𝒕𝒑𝟏 , 𝒕𝒑𝟐 , 𝒕𝒎) = 𝒙𝒊 (𝒑𝟏 , 𝒑𝟐 , 𝒎), for 𝒙𝟏 ∗ and 𝒙𝟐 ∗ , my demand for any of the goods will
not be affected by a “pure inflation” during which all prices and income rise proportionally.
Hence, my demands will continue to be the same in quantity of the goods.
 4. Is good 1 normal or inferior? How about good 2? Show the basis for your answer.

𝝏𝒙𝒊
As defined, if goods 𝒙𝟏 and 𝒙𝟐 are normal goods, then ≥ 𝟎. On the other hand, if goods 𝒙𝟏
𝝏𝒎
𝝏𝒙𝒊
and 𝒙𝟐 are inferior goods, then < 𝟎.
𝝏𝒎
𝟐𝒎 𝒎
From number 2 : 𝒙𝟏 ∗ = , 𝒙𝟐 ∗ =
(𝟐𝒑𝟏 +𝒑𝟐 ) (𝟐𝒑𝟏 +𝒑𝟐 )

To simplify, 𝒙𝟏 ∗ = 𝟐𝒎(𝟐𝒑𝟏 + 𝒑𝟐 )−𝟏 , 𝒙𝟐 ∗ = 𝒎(𝟐𝒑𝟏 + 𝒑𝟐 )−𝟏

𝝏𝒙𝟏 ∗ 𝟐
≥𝟎= > 𝟎 ⟹ good 𝒙𝟏 ∗ is a normal good
𝝏𝒎 𝒑𝟐 +𝟐𝒑𝟏

𝝏𝒙𝟐 ∗ 𝟏
≥𝟎= > 𝟎 ⟹ good 𝒙𝟐 ∗ is a normal good
𝝏𝒎 𝒑𝟐 +𝟐𝒑𝟏

Goods 𝒙𝟏 and 𝒙𝟐 are normal goods because there will be an increase in the quantities demanded
for both goods as my income increases.

5. Find your indirect utility function. Simplify your answer.

The optimal values of goods 𝒙𝟏 and 𝒙𝟐 can be used to find the indirect utility function which is
shown by:
𝑼∗ = 𝑼(𝒙𝟏 ∗ , 𝒙𝟐 ∗ )
Given:
𝑼 = 𝒎𝒊𝒏{𝟑𝒙𝟏 , 𝟔𝒙𝟐 }
𝟐𝒎 𝒎
From Number 2: 𝒙𝟏 ∗ = , 𝒙𝟐 ∗ =
(𝟐𝒑𝟏 +𝒑𝟐 ) (𝟐𝒑𝟏 +𝒑𝟐 )

Substituting for 𝒙𝟏 ∗ and 𝒙𝟐 ∗ , we get 𝑼∗ = 𝑼( 𝒙𝟏 (𝒑𝟏 , 𝒑𝟐 , 𝒎), 𝒙𝟐 (𝒑𝟏 , 𝒑𝟐 , 𝒎)) = 𝑽(𝒑𝟏 , 𝒑𝟐 , 𝒎)

𝑼∗ = 𝒎𝒊𝒏{𝟑𝒙𝟏 , 𝟔𝒙𝟐 }
𝟐𝒎 𝒎
𝑼∗ = {𝟑 ((𝟐𝒑 )
) , 𝟔 ((𝟐𝒑 )}
𝟏 +𝒑𝟐 𝟏 +𝒑𝟐 )

𝟔𝒎 𝟔𝒎
𝑼∗ = {(𝟐𝒑 ,
) (𝟐𝒑
}
𝟏 +𝒑𝟐 𝟏 +𝒑𝟐 )

𝟔𝒎
𝑼∗ = {(𝟐𝒑 }
𝟏 +𝒑𝟐 )
 6. Find your expenditure function. Show and briefly discuss how you arrived at your
answer.

The expenditure function shows that the minimal expenditures necessary to achieve a given
utility level for a particular set of prices.
By the duality theorem 𝑼 = 𝑼∗ since 𝑼∗ = 𝑼 , then the minimum expenditure necessary to
achieve 𝑼 will be such that 𝑬′ = 𝒎.

From Number 5:
𝟔𝒎
𝑼∗ = { }=𝑼 (by the duality theorem)
(𝟐𝒑𝟏 +𝒑𝟐 )

We solve 𝒎 in order to get 𝑬′ since 𝑬′ = 𝒎 as long as 𝑼 = 𝑼∗ .

𝟔𝒎
[(𝟐𝒑 ]=𝑼
𝟏 +𝒑𝟐 )

𝟔𝒎
(𝟐𝒑𝟏 + 𝒑𝟐 ) [ ] = 𝑼(𝟐𝒑𝟏 + 𝒑𝟐 )
(𝟐𝒑𝟏 +𝒑𝟐 )

𝟔𝒎 = 𝑼(𝟐𝒑𝟏 + 𝒑𝟐 )
𝟔𝒎 𝑼(𝟐𝒑𝟏 +𝒑𝟐 )
=
𝟔 𝟔
𝑼(𝟐𝒑𝟏 +𝒑𝟐 )
𝒎=
𝟔
𝑼(𝟐𝒑𝟏 +𝒑𝟐 )
Since 𝑬′ = 𝒎, and 𝒎 = ,
𝟔
𝑼(𝟐𝒑𝟏 +𝒑𝟐 )
∴ 𝑬′ = = 𝑬(𝒑𝟏 , 𝒑𝟐 , 𝑼)
𝟔
 7. Use Shephard’s Lemma to find your Hicksian demand functions for the two goods.

An Individual’s Hicksian demand function depends on preferences, all prices and utility level. It
can be derived using Shephard’s Lemma which is represented by;

𝝏𝑬(𝒑𝟏 , 𝒑𝟐 , 𝑼)
𝒙𝒄𝟏 =
𝝏𝒑𝟏
𝝏𝑬(𝒑𝟏 , 𝒑𝟐 , 𝑼)
𝒙𝒄𝟐 =
𝝏𝒑𝟐

From Number 6;
𝑼(𝟐𝒑𝟏 +𝒑𝟐 )
𝑬(𝒑𝟏 , 𝒑𝟐 , 𝑼) = ≡ 𝑼(𝟐𝒑𝟏 + 𝒑𝟐 )(𝟔)−𝟏
𝟔

𝝏𝑬(𝒑𝟏 ,𝒑𝟐 ,𝑼) 𝟐 𝟏 𝟏

𝒙𝒄𝟏 = = (𝟐)(𝟔)−𝟏 = = ∴ 𝒙𝒄𝟏 (𝒑𝟏 , 𝒑𝟐 , 𝑼) =
𝝏𝒑𝟏 𝟔 𝟑 𝟑
𝝏𝑬(𝒑𝟏 ,𝒑𝟐 ,𝑼) 𝟏 𝟏
𝒙𝒄𝟐 = = (𝟏)(𝟔)−𝟏 = ∴ 𝒙𝒄𝟐 (𝒑𝟏 , 𝒑𝟐 , 𝑼) =
𝝏𝒑𝟐 𝟔 𝟔