ECON5210 Lecture 2: Consumer Demand

Rui Tang, HKUST

Email: ruitang@ust.hk
Office hour: Tuesday 4-5 p.m.
Roadmap

Suppose a consumer’s preference is regular, how do we define the demand

function of the consumer?

What are the properties of the consumer’s demand function?

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Consumer’s Utility Function

Suppose that there are n goods in the market.

The space is R+n . Each x ∈ R+n is called a consumption bundle.
For instance, n = 3 and x = (1, 2, 4) means that in the bundle x, there is 1
unit of good 1, 2 units of good 2 and 4 units of good 3.
We always assume that the consumer’s preference % over R+n is (1)
continuous and (2) monotone. By Lecture 1, % can be represented by some
continuous function u. u must also be monotone:

x ≥ y ⇒ u(x) ≥ u(y ),

x  y ⇒ u(x) > u(y ).

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Price

Let p  0 be the price vector, where pk denote the unit price of good k for
each k ∈ {1, ..., n}.
Let w be the consumer’s wealth or income.
The budget set of the consumer is

B(p, w ) := {x ∈ R+n : x · p ≤ w }.

B(p, w ) contains all consumption bundles that cost less than or equal to w
under price p. In other words, B(p, w ) are all affordable consumption
bundles of the consumer.

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Consumer’s Problem

The consumer’s choice set is B(p, w ), and her choice problem is to choose
x ∈ B(p, w ) such that
x ∈ arg max u(y ).
y ∈B(p,w )

In order to characterize the consumer’s optimal consumption bundle, we need to

make sure that such an optimal consumption bundle always exists.

Proposition
For any p  0 and w > 0, and any continuous utility function u,

arg max u(y )

y ∈B(p,w )

is not empty.

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Compact Sets

Definition
S i
A is compact in a metric space X if: whenever A ⊆ O (each O i is open), then
i∈I
there exists a finite subset I 0 ⊆ I such that A ⊆
S i
O.
i∈I 0

Fact. In Euclidean space, a set A is compact if and only if it is closed and

bounded. The budget set B(p, w ) is bounded and closed, and thus compact.

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Example
S∞
Consider B1 (o) ⊆ R n : B1 (o) ⊆ n=2 B1− n1 (o) ⇒ no finite covering. B1 (o) is
bounded but not closed.
S∞
Consider interval [0, +∞) ⊆ R: [0, +∞) ⊆ k=1 (−1, k) ⇒ no finite
covering. [0, +∞) is closed but unbounded.

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Weierstrass Theorem
Theorem
For any continuous function u : X → R and any compact set A ⊆ X , there exists
x ∈ A such that u(x) ≥ u(y ), ∀y ∈ A.

Proof.
Consider u and A. u is continuous ⇒ for any a ∈ R, {x ∈ X : u(x) < a} is
open.
Suppose to the contrary that for any x ∈ A, there is x 0 ∈ A such that
u(x 0 ) > u(x).
It follows that [
A⊆ {x ∈ X : u(x) < u(y )}.
y ∈A

Since A is compact, there exists finite points {y 1 , ..., y l } ⊆ A such that

l
[
A⊆ {x ∈ X : u(x) < u(y i )}.
i=1
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Weierstrass Theorem

Proof Continued.
Since
l
[
A⊆ {x ∈ X : u(x) < u(y i )},
i=1

we know that for each x ∈ A, there exists some y i ∈ A such that

u(x) < u(y i ).

∗ ∗
Consider y i such that u(y i ) ≥ u(y i ) for each i, contradiction.

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Consumer’s Demand

Define x̄(p, w ) := {x ∈ B(p, w ) : u(x) ≥ u(y ), ∀y ∈ B(p, w )} as the demand

correspondence of the consumer.
Fact: x̄(p, w ) is nonempty and compact.
x̄(p, w ) is compact since (1) it is bounded and (2) closed
\
x̄(p, w ) = {x ∈ B(p, w ) : u(x) ≥ u(y )}.
y ∈B(p,w )

(union of open sets is open, and intersection of closed sets is closed)

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More on Continuity

Proposition
Suppose % is continuous. If |x̄(p, w )| = 1 for any p  0 and w > 0, then x̄(p, w )
n
is a continuous function on R++ × R++ .

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Monotonicity

Monotonicity indicates that for each x ∈ x̄(p, w ), it must hold that

x · p = w , budget identify.

Simple proof: if there exists x ∈ x̄(p, w ) such that x · p < w , then we can
consider y = x + (, , ..., ) for small enough  > 0. y is strictly better than
x and affordable, contradiction.

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Monotonicity v.s. Strong Monotonicity

Example
Strong monotonicity and monotonicity might have different properties on the
limit. Consider two utility functions over R+2 : u s (x, y ) = min{x, y } and
u f (x, y ) = x + y . If can be easily verified that for p n = (1, n1 ) where n ≥ 2 and
w = 1, we have
n n
x̄ s (p n , w ) = ( , ) and x̄ f (p n , w ) = (0, n).
n+1 n+1
This implies

lim x̄ s (p n , w ) = (1, 1) and lim x̄ f (p n , w ) = (0, +∞).

n→+∞ n→+∞

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Boundary Property

Proposition
Suppose that % is continuous and strongly monotone, and |x̄(p, w )| = 1 for all
p  0 and w > 0, if a sequence {(p k , w k )}∞
k=1 converges to (p, w ) such that
w > 0 and pi = 0 for some i, then define I = {i : pi = 0}, we have
X
lim xik = +∞,
k→+∞
i∈I

where x k = x̄(p k , w k ).

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Convex Preference

Definition
A ⊆ R n is convex if for any x, y ∈ A and any t ∈ [0, 1], tx + (1 − t)y ∈ A.

Example
The budget set B(p, w ) is convex: if x, y ∈ B(p, w ), then

x · p ≤ w, y · p ≤ w.

For any t ∈ (0, 1), we have

(tx + (1 − t)y ) · p ≤ w ⇒ tx + (1 − t)y ∈ B(p, w ).

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Convex Preference

Definition
% is convex if x % y ⇒ tx + (1 − t)y % y , ∀t ∈ [0, 1].
% is strictly convex if for x 6= y , x % y ⇒ tx + (1 − t)y  y , ∀t ∈ (0, 1).

Definition
A function u : X → R is quasiconcave if for all x, y ∈ X and t ∈ [0, 1],

u(tx + (1 − t)y ) ≥ min{u(x), u(y )}.

A function u : X → R is strictly quasiconcave if for all x 6= y and t ∈ (0, 1),

u(tx + (1 − t)y ) > min{u(x), u(y )}.

Remark. Suppose that u represents %, then % is (strictly) convex ⇔ u is

(strictly) quasiconcave.

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Convex Preference

Definition
A function u : X → R is concave if for all x, y ∈ X and t ∈ [0, 1],

u(tx + (1 − t)y ) ≥ tu(x) + (1 − t)u(y ).

A function u : X → R is strictly concave if for all x 6= y and t ∈ (0, 1),

u(tx + (1 − t)y ) > tu(x) + (1 − t)u(y ).

Proposition
Concave ⇒ quasiconcave; strictly concave ⇒ strictly quasiconcave.

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Convex Preference
Example
Any strictly increasing function u : R → R is strictly quasiconcave: x > y ⇒
x > tx + (1 − t)y > y for t ∈ (0, 1), and thus u(tx + (1 − t)y ) > u(y ) =
min{u(x), u(y )}.
Not every strictly increasing function u is concave. Consider u(x) = x 3

y 0.5x + 0.5y

However, one can easily check that û(x) = x is concave. But ū and u represent
the same preference!

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Convex Preference

Example
Here is an example of strictly concave function: u : R → R such that
u(x) = 2 − x 2 .

tx + (1 − t)y
x

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Proposition
Suppose that % is monotone and continuous. If % is convex, then x̄(p, w ) is a
convex set. If % is strictly convex, then x̄(p, w ) contains only one point.

Proof.
First, assume that % is convex. To see that x̄(p, w ) is convex, consider
x, y ∈ x̄(p, w ) and any t ∈ [0, 1].
Since x ∼ y , we have tx + (1 − t)y % x ∼ y . Hence, tx + (1 − t)y is also an
optimal consumption bundle.
Next, assume % is strictly convex. If x̄(p, w ) contains x and y such that
x 6= y , we have for t ∈ (0, 1), tx + (1 − t)y  x ∼ y , contradiction.

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Corollary
If % is monotone, strictly convex and continuous, then x̄(p, w ) is a continuous
function.

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Example
In R+2 , convexity indicates that the consumer’s demand is always an interval on
the boundary of the budget set:

y
x

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Concave and Quasiconcave Utility Functions

Example
Cobb-Douglas Utility Function:

U(x1 , x2 , ..., xn ) = x1α1 x2α2 ...xnαn

where αi > 0 for each i.

Claim: Cobb-Douglas utility function is quasiconcave.
Recall that if % is represented by u, then any monotone transformation
v = φ(u) of u also represents %: v (x) ≥ v (y ) if and only if u(x) ≥ u(y ).
If u and v simultaneously represent %, then u is quasiconcave if and only if v
is quasiconcave.

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Example
Cobb-Douglas Utility Function:

U(x1 , x2 , ..., xn ) = x1α1 x2α2 ...xnαn

where αi > 0 for each i.

Pn
Define v (x1 , x2 , ..., xn ) = ln(U(x1 , x2 , ..., xn ) = i=1 αi ln xi .
v is concave since v is the summation of n concave functions:
n
X
v (x1 , ..., xn ) = v i (x1 , ..., xn )
i=1

where v i (x1 , ..., xn ) = αi ln xi .

Thus, v is quasiconcave, and thus U is quasiconcave.
However, U is not necessarily concave, e.g., when n = 2 and α1 = α2 = 1.
U(x1 , x2 ) = x1 x2 is not concave.

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Characterization by Differentiation

When the utility function of the consumer is monotone and differentiable, we have
a Lagrange multiplier characterization of the consumer’s demand.

Proposition
Suppose the consumer’s utility function u is monotone and differentiable. If
x ∗ ∈ x̄(p, w ) such that x ∗  0, and there exists i ∈ {1, ..., n} such that

∂u ∗
(x ) > 0,
∂xi
then there exists λ > 0 such that
∂u ∗
∀k ∈ {1, ..., n}, (x ) = λpk .
∂xk

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Proof.
If 1 ∂u
pi ∂xi (x ∗ ) > 1 ∂u
pj ∂xj (x ∗ ) for some i and j. WLOG, let i = 1 and j = 2.
We can consider another consumption bundle y ∗ = x ∗ + ( p1 , − p2 , 0, ..., 0).
When  > 0 is close enough to 0, y ∗ is a valid consumption bundle.
When  is close to 0, we know
 ∂u ∗  ∂u ∗
u(y ∗ ) = u(x ∗ ) + (x ) − (x ) + o() > u(x ∗ ).
p1 ∂x1 p2 ∂x2

Since y ∗ is affordable and u(y ∗ ) > u(x ∗ ), we have a contradiction.

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Lagrange Multiplier

λ= 1 ∂u
pk ∂xk (x ∗ ) is called the Lagrange multiplier.
λ captures how the consumer’s utility would increase if her constraint is
relaxed by 1. Here, the constraint is income.
Following this idea, if the optimal consumption bundle is x ∗ = (0, 2, 3), how
do we define λ?
We should have
1 ∂u ∗ 1 ∂u ∗ 1 ∂u ∗
λ= (x ) = (x ) ≥ (x ).
p2 ∂x2 p3 ∂x3 p1 ∂x1

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Solving for the Optimal Consumption Bundle

Suppose there are n goods.

If the preference is monotone, then the optimal bundle satisfies the budget
identify.
If you can prove that the optimal consumption bundle must be interior, i.e.,
x ∗  0, then you have the marginal utility over price is constant, which gives
you n − 1 conditions.
If you know the demand for m goods of the n is 0, then you the marginal
utility over price is constant for the rest n − m goods, which again gives you
n − m − 1 conditions.

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Cobb-Douglas Utility Function

Recall the Cobb-Douglas utility function is equivalent to

u(x1 , ..., xn ) = α1 ln(x1 ) + ... + αn ln(xn ).

Since ln(0) = −∞, the optimal consumption bundle must be x ∗  0.

We have
∂u αi
= = λpi , ∀i.
∂xi xi

The condition can be transferred to

αi αj
= , ∀i, j.
xi pi xj pj

The consumer will spend Pnαi w buying good i ⇒ xi = Pnαi w

j=1 αj j=1 αj pi .

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Conclusion

% continuous (∃ continuous u representing %) ⇒ x̄(p, w ) is non-empty.

% (u) monotone ⇒ budget identify.
% (u) strongly monotone + continuity ⇒ boundary property.
% convex (u quasiconcave) ⇒ x̄(p, w ) is a convex set.
% strictly convex (u is strictly quasiconvex) ⇒ x̄(p, w ) is a point.
u (strictly) concave ⇒ u (strictly) quasiconcave ⇒ % (strictly) convex.

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