Stone-Geary Utility Maximisation

Harold Walden
The corresponding video can be found at: https://youtu.be/qHZHAJozLc8

The Stone-Geary unction is often used to model problems involving subsistence levels of consumption. In these cases, a certain
minimal level of some good has to be consumed, irrespective of its price or the consumer’s income – for example; food and water.

In the two-good case, consumers will first set aside a subsidence level of consumption of the two goods; A and B of 𝛼 for good A
and 𝛽 for good B. The Stone Geary utility function is based on the traditional Cobb-Douglas utility function 𝑈 𝐴, 𝐵 = 𝐴( 𝐵)*(
where 𝛾 is the proportion of each of good A and B consumed (consequently, 𝛾 ∈ ℝ; 0 ≤ 𝛾 ≤ 1 )

As a result the Stone-Geary utility function for the two-good case can be presented as the following;
𝑈 𝐴, 𝐵 = 𝐴 − 𝛼 ( 𝐵 − 𝛽 )*(
or more simply;
𝑢 𝐴, 𝐵 = ln 𝑈 𝐴, 𝐵 = 𝛾 ln( 𝐴 − 𝛼) + (1 − 𝛾) ln 𝐵 − 𝛽

The derivation of consumer demand involving the subsistence levels of consumption involves the same method as the regular
Cobb-Douglas (maybe with a sexier standard of algebra) however, in its derivation we will yield some interesting results.

To begin with let us first set up the consumer utility optimisation problem and the resulting Lagrangian function.
Maximise: 𝑢 𝐴, 𝐵 = 𝛾 ln( 𝐴 − 𝛼) + (1 − 𝛾) ln 𝐵 − 𝛽
Subject to: 𝑀 = 𝑃< 𝐴 + 𝑃= 𝐵

Hence,
ℒ = 𝛾 ln( 𝐴 − 𝛼) + (1 − 𝛾) ln 𝐵 − 𝛽 + 𝜆 𝑀 − 𝑃< 𝐴 − 𝑃= 𝐵

Differentiating with respect to 𝐴, 𝐵 and 𝜆 yields the first order conditions:

𝑑ℒ 𝛾
= − 𝜆𝑃< = 0
𝑑𝐴 𝐴 − 𝛼
𝑑ℒ 1−𝛾
= − 𝜆𝑃= = 0
𝑑𝐵 𝐵 − 𝛽
𝑑ℒ
= 𝑀 − 𝑃< 𝐴 − 𝑃= 𝐵 = 0
𝑑𝜆

Using the first two conditions we can eliminate the Lagrangian Multiplier and find both A and B in terms of their allocation (𝛾),
their price 𝑃< , 𝑃= and their subsistence consumption (𝛼, 𝛽).
𝛾
= 𝜆𝑃<
𝐴−𝛼
1−𝛾
= 𝜆𝑃=
𝐵−𝛽
𝜆𝑃< 𝛾 𝐵−𝛽
= ×
𝜆𝑃= 𝐴 − 𝛼 1 − 𝛾
𝑃< 𝛾(𝐵 − 𝛽)
=
𝑃= (𝐴 − 𝛼)(1 − 𝛾)
𝑃< 𝐴 − 𝛼 1 − 𝛾 = 𝑃= 𝛾(𝐵 − 𝛽)

𝑃< (𝐴 − 𝛼 )(1 − 𝛾 ) = 𝑃= 𝛾 (𝐵 − 𝛽) 𝑃< (𝐴 − 𝛼 )(1 − 𝛾 ) = 𝑃= 𝛾 (𝐵 − 𝛽)

𝑃= 𝛾 (𝐵 − 𝛽) 𝑃< (1 − 𝛾 )(𝐴 − 𝛼)
𝐴−𝛼= 𝐵−𝛽 =
𝑃< (1 − 𝛾 ) 𝑃= 𝛾
𝑃= 𝛾 (𝐵 − 𝛽) 𝑃< (1 − 𝛾 )(𝐴 − 𝛼)
𝐴=𝛼+ 𝐵=𝛽+
𝑃< (1 − 𝛾 ) 𝑃= 𝛾
 Bℒ
Substituting into the third condition; = 𝑀 − 𝑃< 𝐴 − 𝑃= 𝐵 = 0
BC

𝑀 = 𝑃< 𝐴 + 𝑃= 𝐵
𝑃< 1 − 𝛾 (𝐴 − 𝛼)
𝑀 = 𝑃< 𝐴 + 𝑃= 𝛽 +
𝑃= 𝛾
𝑃< 𝑃= 1 − 𝛾 (𝐴 − 𝛼) ß The 𝑃= cancel out
𝑀 = 𝑃< 𝐴 + 𝑃= 𝛽 +
𝑃= 𝛾
𝑃< 1 − 𝛾 (𝐴 − 𝛼)
𝑀 = 𝑃< 𝐴 + 𝑃= 𝛽 +
𝛾
𝑃< 1 − 𝛾 (𝐴 − 𝛼)
𝑀 − 𝑃= 𝛽 = 𝑃< 𝐴 +
𝛾
1−𝛾 ß just rearranging for neatness and to make it easier to follow
𝑀 − 𝑃= 𝛽 = 𝑃< 𝐴 + 𝑃< (𝐴 − 𝛼)
𝛾
𝑃< 𝐴 𝑃< 𝛼
𝑀 − 𝑃= 𝛽 = 𝑃< 𝐴 + − (1 − 𝛾)
𝛾 𝛾
𝑃< 𝐴 𝑃< 𝛼
𝑀 − 𝑃= 𝛽 = 𝑃< 𝐴 + − − 𝑃< 𝐴 + 𝑃< 𝛼 ß combining like terms
𝛾 𝛾
𝑃< 𝐴 𝑃< 𝛼
𝑀 − 𝑃= 𝛽 = − + 𝑃< 𝛼
𝛾 𝛾
𝑃< 𝐴 𝑃< 𝛼 (
𝑀 − 𝑃< 𝛼 − 𝑃= 𝛽 = − ß multiplying both sides of the equality by
𝛾 𝛾 EF

𝛾 𝛾 𝑃< 𝐴 𝑃< 𝛼
𝑀 − 𝑃< 𝛼 − 𝑃= 𝛽 = −
𝑃< 𝑃< 𝛾 𝛾
𝛾
𝑀 − 𝑃< 𝛼 − 𝑃= 𝛽 = 𝐴 − 𝛼
𝑃<
Therefore the Marshallian Demand Function for Good A is;
𝛾
𝐴D = 𝛼 + 𝑀 − 𝑃< 𝛼 − 𝑃= 𝛽
𝑃<
and by symmetry, the Marshallian Demand Function for Good B is;
1−𝛾
𝐵D = 𝛽 + 𝑀 − 𝑃< 𝛼 − 𝑃= 𝛽
𝑃=
Important points to take away from this derivation:
- Each of the functions of 𝐴D and 𝐵 D are the Marshallian demand functions for the Stone-Geary utility.
- The first term on the right-hand-side of the equality, is the subsistence consumption. A consumer will always consume
this amount irrespective of their budgets or the price.
- The 𝑀 − 𝑃< 𝛼 − 𝑃= term is the income the consumer has left over, after the subsistence levels are met. It is in effect, the
residual income.
- The amount of A and B that this residual income is used to buy, is now negatively influenced by price, and positively
influenced by the good’s importance. For instance, if γ increases, it implies that good A is relatively more important than
B. According to these demand functions, our consumer will purchase less of B and more of A, all other things equal.

Hope it helps J

Harold