Cobb-Douglas Utility Function

By Adrián Brenes

Version 2.5

September 21st, 2023

The aim of this document is to deduce some usual formulas in microeconomics for a Cobb-

Douglas utility function. If you have any comments or doubts, please report them to

adrianbrenescr@gmail.com.

1. General Cobb-Douglas utility function

1.1. The general Cobb-Douglas utility function is g= A x α y β . The universe of goods is

composed by goods x and y . Due to mathematical restrains, and since x and y are goods, only

positive quantities for them will be considered. A , α , and β are all parameters which will be

kept constant throughout. We have that A> 0, α >0, and β >0.

2. Monotonic transformation

2.1. A monotonic transformation of the general function in 1.1 describes the same

preferences as that general function. In particular, u=x α y 1−α is a monotonic transformation

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of the function in 1.1 where A=1 and β=1−α . Plus, the parameter α is further restricted to

be smaller than 1, so that we have finally enclosed this parameter such that 0< α <1.

Throughout, the utility function hereby described will be referred to as the simple Cobb-

Douglas function.

2.2. The proof that the simple function is a monotonic transformation of the general version

∂ [g ( x , y )] ∂ [ g ( x , y ) ] ∂ ( A x α y β ) ∂ ( A y β+ α−1 u ) β+ α −1
amounts to prove that >0 . Since = = =A y ,
∂ [u ( x , y )] ∂ [u ( x , y )] ∂ ( u) ∂u

this expression is positive because A> 0 and y >0 .

UTx, UMgx, Law of diminishing marginal utility.

3. Indifference curve

3.1. Let a bundle to be a set of positive quantities of each good ( x and y in our simple Cobb-

Douglas utility function). Let an indifference curve to be a set of bundles, each of which

bundles renders the same level of utility, u0 .

3.2. The indifference curve for a level of utility u0 for the simple Cobb-Douglas utility

function, u=x α y 1−α , is obtained from solving in that function for y . So, the indifference curve

1/ ( 1−α ) −α / ( 1−α )
for u0 is y=u 0 x .

4. Marginal rate of substitution

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4.1. The marginal rate of substitution is the first derivative of the indifference curve with

respect to the good working as the argument of that function.

4.2. The marginal rate of substitution of the simple Cobb-Douglas function is

−α
u01 /(1−α )
∂y −α 1 / ( 1− α ) −1 (1−α )
y= = u0 x =
∂ x ( 1−α ) x

4.3. The marginal rate of substitution of the simple Cobb-Douglas function is negative for

positive levels of both x and y . To conclude this, first remember that α was defined as positive

(bigger than 0 and smaller than 1). Plus, with both x and y positive besides positive α , u0

must be also positive. With x positive, by hypothesis, it must be concluded that the marginal

rate of substitution of the simple Cobb-Douglas utility function is negative.

5. Convexity of the indifference curve

5.1. An indifference curve with negative marginal rate of substitution is convex if its second

derivative is positive.

5.2. The convexity of an indifference curve helps in the pursuance of an interior solution. An

interior solution is a consumer optimum characterized by consumption of all goods. An

interior solution is antonym of a corner solution. An interior solution is guaranteed when the

range of possible values for the marginal rate of substitution covers or contains the slope of

the budget constraint.

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5.3. When an indifference curve is smooth, has no kinks, its convexity also guarantees that at

the consumer optimum, the indifference curve is tangent to the budget constraint.

5.4. An indifference curve with negative marginal rate of substitution is convex if its second

derivative is positive.

5.5. In the case of the simple Cobb-Douglas utility function, the second derivative of the

indifference curve with respect to the good working as the argument of that function is

α
2
u01 /(1−α )
∂ y α 1 / ( 1−α ) −2 (1−α )
y= = u0 x =
∂ x (1−α )
2 2
x

5.6. By an analysis analogous to that of 14.3, it is concluded that the second derivative of the

typical indifference curve of the simple Cobb-Douglas utility function is positive, then such a

curve is convex, which is the same than saying that simple Cobb-Douglas preferences are

convex.

6. Budget

6.1. Let px+ ry be the agent’s expenditure in goods x and y . The price for good x is p and

the price for good y is r . Let us assume that prices do not change due to the agent’s choice.

Prices are measured in numeraire.

6.2. Let w be the wealth that the agent possesses to buy x and y . This wealth is measured in

numeraire. By definition, numeraire does not have use value but only exchange value.

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7. Marshallian demand

7.1. Let the Marshallian demand for good x be the quantity of such a good that maximizes u

for every p, given the utility function, the prices for all other goods and the wealth.

7.2. The Marshallian demand can be expressed as x=x ( p , w , r ) given that we are working

with the previously defined Cobb-Douglas function. Since we are not going to analyze the

changes of other prices over the demand of a specific good besides its own price, we can

economize in nomenclature and express the Marshallian demand as x=x ( p , w).

7.3. This does not mean that the concrete magnitude of u is not going to change when the

price changes. Indeed, when p changes, the situation for the agent changes in such a way that

the magnitude of u can perfectly change and, in the case of our Cobb-Douglas function, in fact

changes. What we mean is that the pre-defined Cobb-Douglas form for the utility function is

kept throughout, including the magnitudes for the specific parameter α .

7.4. Note that the Marshallian demand implies that the wealth is the same for every price.

This is, the wealth is an exogenous parameter for this demand.

7.5. To get x ( p , w) we begin by maximizing u subject to the fact that the expenditure cannot

be bigger that the wealth, this is subject to px+ ry ≤ w. Since a Cobb-Douglas utility function

implies monotonic preferences; this is, a bigger quantity of a good is always preferred to a

smaller one, all the wealth will be spent so that we have the constraint to be px+ ry=w .

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7.6. The solution can be found, firstly, by assembling the Lagrange function

α 1−α
L=x y −λ( px +ry −w) and then solving for x . Alternatively, through a second way, one

can solve for y in the restriction, include the result in the Cobb-Douglas function and then

solve for x . A third way is to use h , a monotonic transformation of u, so that

h=α ln x + ( 1−α ) ln y , and then solve through the first or the second ways, since h is

mathematically easier to deal with than u.

7.7. The solution is

αw Equation 1
x=
p

7.8. Or, if you want to make explicit the fact that w is part of the ceteris paribus conditions,

αw
x= . This is the Marshallian demand function for x for our Cobb-Douglas function. Note
p

that, for the individual agent, we are assuming that he is a price taker so that price determines

the quantity to demand: we are making price-into-quantity analysis so that q=f ( p) instead of

the whole market situation according to which a quantity-into-price analysis in which

p=f (q) is more suitable.

( 1−α ) w
7.9. Analogously, you can get the optimum quantity of y . This quantity is y ( p , w)=
r

. A way of getting this function is by substituting the optimum quantity of x in the constraint,

which gives p ( αwp )+ry =w and solve for y .

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7.10. The inverse demand function is…

7.11. The price elasticity of demand of this function is…

7.12. The cross-price elasticity of demand of this function is…

8. Engel curve

8.1. The Engel curve is a mathematical relation which give us the optimal (this is, the utility

maximizing) quantity of a good x for every level of w . Given the form of the preferences (the

utility function) and dismissing from the analysis any other prices apart from p, the Engel

curve is x=x (w , p). Note that this is precisely the Equation 1, but taking a different ceteris

αw
paribus conditions such that x= . This means that the only difference between the
p

Marshallian demand curve and the Engel curve is what variable we take as constant. If we

take w as constant, then we face a demand curve; if we take p as constant, then we find an

Engel curve. Nevertheless, the general function to begin with is the same in both cases.

8.2. The income elasticity of demand of this function is…

8.3. The proportion of income spent in good x is…

9. Wealth expansion path

9.1. The wealth expansion path is the magnitude of y in relation to x for every level of w .

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 px
9.2. Given the Equation 1, you can solve for w , and then use the value of w= to substitute
α

in the Marshallian demand for y , so that you have y=

r ( )( pr ) x. This
( 1−α ) w 1−α
=
α

magnitude of y in relation to x is the wealth expansion path given our Cobb-Douglas function.

10. Price expansion path

10.1. The price expansion path is the magnitude of y in relation to x for every level of p.

10.2. In general, you have, analogously to the case for the wealth expansion path, to solve in

the Equation 1 for p and substitute this magnitude in y (r , w) .

10.3. Nevertheless, since in our Cobb-Douglas function y ( r , w ) is not determined by p, the

( 1−α ) w
price expansion path for p is just a constant which for any magnitude of x gives , the
r

optimum magnitude of y for certain α , w , and r .

αw
10.4. Analogously, the price expansion path for r is a vertical line at the magnitude of x of
p

11. Indirect utility function (Houthakker, 1951)

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11.1. The indirect utility function is the maximum utility level for certain prices and wealth;

given a utility function, in this case our simple Cobb-Douglas function. Let v be this magnitude.

So, we have that v is a function of p, r , and w . This is: v=v ( p , r , w).

11.2. In the exercise of maximizing u for prices and wealth we got the optimum quantities of

the goods x and y precisely in terms of prices and wealth. An easy way of getting v is simply

substituting these magnitudes in the original utility function, so that we have

( )( )
α 1−α
αw ( 1−α ) w
v= . Rearranging terms, we finish with
p r

Equation 2
( )( )
α 1−α
α 1−α
v= w
p r

11.3. The aforementioned strategy for finding a solution is, in essence, the same that finding v

directly from the Lagrangian defined in 2.6.

11.4. Note that v also is the outcome of including the optimum quantities of goods as given by

Marshallian demands into the utility function. This is so because the Marshallian demands

come from maximizing utility for given prices and wealth, which is the same procedure than

in calculating v .

12. Roy’s identity (Roy, 1947)

12.1. The Roy’s identity says that the negative of the derivative of v with respect to p divided

between the derivative of v with respect to w equals the Marshallian demand:

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 −
x ( p , w )=
( ∂ p)
∂v

Equation 3
( ∂∂wv )

12.2. To prove this for our Cobb-Douglas function, first rearrange the Equation 2, so that we

[ ( ) ]
1−α
α 1−α −α
have v= α w p If we derive this function with respect to p, we have
r

[( ) ] [( ) ( ) ]
1−α α 1−α
∂v α 1−α −α−1 −α α 1−α −α
=−α α w p = w= v . By doing the analogous
∂p r p p r p

( )( )
α 1−α
∂v α 1−α v
with the other derivative, we have = = . With this, it is easy to obtain
∂w p r w

αw
that the right side of the Equation 3 amounts to , which, according to Equation 1, is the
p

Marshallian demand for x .

13. Hicksian demand

13.1. The Hicksian demand is a relation between the optimum quantity of a good and its

price, given the other prices and a specific level of utility (not just the form of the utility

function as in the Marshallian demand).

13.2. The Hicksian demand can be expressed as x=x ( p , u , r) given that we are working with

the previously defined Cobb-Douglas function. Since we are not going to analyze the changes

of other prices over the demand of a specific good, we can economize in nomenclature and

express the Hicksian demand as x=x ( p , u).

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13.3. The specific feature of a Hicksian demand is that it is defined for a specific level of

utility, differently from, say, the Marshallian demand, which as told in 2.3, can imply different

levels of utility for different prices.

13.4. Note that, at difference of the Marshallian demand, which is defined for a determined

level of wealth, the level of w can change for every change in price. This is as if the agent

receives a compensating variation in wealth after the price has changed so that he can

continue choosing, as best, a bundle which gives him the same level of utility as he could enjoy

in his optimum at the old p. That is why this demand is sometimes called the compensated

demand curve, although, to be sure, there is also a compensated demand curve à la Slutsky,

which is presented in 12.

13.5. The Hicksian demand is gotten by minimizing the expenditure given a level of utility

(and the prices of the goods and the form of the utility function). This can be obtained by

solving for x the Lagrangian L= px +ry− λ( x α y 1−α −u) , which gives the first order conditions

for a minimum in the context of the simple Cobb-Douglas and expenditure functions. Basically,

you have to derive with respect to x , y , and of course λ ; equalize all these derivatives to zero;

and solve for x and y in terms of p, r , and u (and of course, the parameter α ).

13.6. The solution is

[ ]
α r
1−α
Equation 4
x= u
( 1−α ) p

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 [ ]
α
( 1−α ) p
13.7. Analogously, the Hicksian demand for y is y ( r ,u )= u.
α r

13.8. An alternative solution to get Hicksian demands is through the Shephard’s lemma. This

solution is presented in 10.

()
1−α
r
13.9. Sometimes x ( p , u) is delivered as α u ; nevertheless, this is incorrect since this is
p

the Hicksian demand for a utility function u=α ln x + ( 1−α ) ln y , which, OK, is a monotonic

transformation of the Cobb-Douglas function but it is not itself a Cobb-Douglas function.

14. Expenditure function

14.1. The expenditure function relates the minimum expenditure related to every level of

utility, given prices, wealth, and of course the form of the utility function. Let e be that

magnitude of expenditure; then we have e=e(u , p , r , w) or simply e=e(u).

14.2. A way of finding a solution is solving the Lagrangian assembled in 8.5. Once you have

gotten the solutions for x and y , i.e. its Hicksian demands, you have to substitute these

magnitudes of x and y into the expenditure px+ ry , which outcome is our desired e . So, we

have e (u )= p ∙ x ( p ,u )+ r ∙ y (r , u). Arranging terms, we have

Equation 5
( )( )
α 1−α
p r
e= u
α 1−α

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14.3. Other way of finding the solution is through v . By realizing that v is the maximum utility

for certain levels of prices and wealth, and taking into account that for the simple Cobb-

Douglas function all the wealth is always spent, we can simply notice that the Equation 2

( )( )
α 1−α
α 1−α
implies u= e.
p r

14.4. Analogously to 6.4, e comes from including the optimum quantities of goods as given by

Hicksian demands into the general agent’s expenditure, px+ ry . This is so because the

Hicksian demands come from minimizing w for given prices and level of utility, which is the

same procedure than in calculating e .

15. Shephard’s lemma

15.1. In the context of consumer theory, the Shephard’s lemma states that the Hicksian

demand for a good can be obtained by deriving e (u) with respect to the price of such a good.

For the case of x , we have

∂e Equation 6
=x( p , u)
∂p

[ ( ) ]
1−α
−α r α
15.2. To prove it, let us rearrange the Equation 5, so that e= α u p , which make
1−α

[ ( ) ] [ ]
1−α 1−α
∂e −α r α −1 α r
it easier to see that =α α u p = u=x ( p , u).
∂p 1−α ( 1−α ) p

15.3. Note that deriving e (u )= p ∙ x ( p ,u )+ r ∙ y ( p , r ,u) with respect to p doesn’t amount to

trivially deriving as if x and y were constants so that you finish with the constant multiplying

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p. The Hicksian demand for x as well as the Hicksian demand for y (the latter here expressly

showing p as one of his arguments) are functions of p. So, the Shephard’s lemma makes the

∂e
much less trivial assertion that =x( p , u) taking into account that x ( p , u ) and y (r , u) in
∂p

general (and certainly in the case of Cobb-Douglas) are both functions of p and that have

therefore to be derived and of course follow, where applicable, the respective product rule of

derivation.

15.4. As an exercise, you can prove this procedure for y (r , u).

16. Slutsky equation for a Hicksian demand

16.1. The idea underlying the Slutsky equation is that the change in the optimum quantity of a

good given a change in its price, ceteris paribus, can be separated between a pure

substitution-effect (a change in the price relative to the prices of the other goods) and a

wealth-effect (a change in price relative to the wealth, which can be understood as a change in

the purchasing power of the wealth itself).

16.2. The Slutsky equation relating a Marshallian demand and a Hicksian demand is this:

∂ x( p , w) ∂ x ( p ,u) ∂ x( p , w) Equation 7
= − x
∂p ∂p ∂w

16.3. You can interpret the last term x as being either x ( p , w) or x ( p , u) since for an

optimum, they amount to the same magnitude.

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16.4. The change in wealth due to a change in a price can be defined in various ways. In

general, the agent must receive a compensation in wealth in order for just the substitution-

effect to remain. But that compensating variation in wealth can be one that allows reaching

again the indifference curve affordable with the old optimum bundle or can be one that allows

to barely buy the old optimum bundle or whatnot.

16.5. If you define the compensating variation in wealth as one which allows to remain in the

same indifference curve (although choosing different bundles depending on the change in the

price of the good under analysis), you can realize that the reaction of the Hicksian demand for

x to a change in its price, p, this is the derivative of x ( p , u ) with respect to p, accounts for the

[( ) ]
1−α
α α−1
substitution effect. Rearranging the Hicksian demand for x as x ( p , u ) = r u p ,
1−α

∂ x ( p , u)
you can realize that =(−1 ) ∙ α 1−α ∙ ( 1−α )α ∙ r 1−α ∙ u ∙ p α −2
∂p

{ [( ) ( ) ] } ( )
α 1−α
p r
( 1−α ) u
α 1−α α (1−α ) e . Taking into account that for x ( p , w )
()
¿ (−1 )
α
p p
=(−1 )
p p

as much as for x ( p , u ) , we are working with optimum magnitudes, we can substitute e (u)

with w , so that the derivative can be finally stated as (−1 ) ()α (1−α ) w
p p
.

∂ x ( p , w)
16.6. You can also realize that the full price-effect on x is given by , this is by the
∂p

reaction of the Marshallian demand to a change in price. So, you have

∂ x( p , w) −αw
∂p
= 2 =−
p
α w
p p
. ()

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16.7. The wealth effect, the full price-effect minus the substitution effect, can be formulated

∂ x ( p , w ) ∂ x (p ,u)
as − . From 11.3 and 11.4, you can find that this amounts to
∂p ∂p

− ( αp ) wp − (−1) ( αp ) ( 1−αp ) w =( αp ) αwp . The first part, αp is no other than ∂ x(∂pp, w) and the
αw
second term, , is the very x ( p , w).
p

ELASTICITY VERSION OF SLUTSKY EQUATION: epsilon = eta minus alpha zeta

17. Slutsky’s demand

17.1. The Slutsky’s demand is a compensated demand relation between the optimum

quantity of a good and its price, given the other prices and a specific level of purchasing power

represented as the affordability of certain bundle which can be assimilated as an initial

endowment. This endowment can be represented through the bundle { x d , y d }.

17.2. The Slutsky’s demand can be expressed as x=x ( p , x d , y d ,r ). Since we are not going to

analyze the changes of other prices over the demand of a specific good, we can economize in

nomenclature and express the Slutsky’s demand as x=x ( p , x d , y d ).

17.3. The Slutsky’s demand can imply different levels either of u or of w , but it always allows

to afford the bundle { x d , y d }, although the agent can buy or sell from his endowment at the

given prices in order to reach an optimum.

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17.4. The Slutsky’s demand is gotten by maximizing the utility given a particular budget

constraint. This constraint limits the expenditure to the endowment so that

px+ ry ≤ p x d +r y d . Once again, since the Cobb-Douglas are homothetic (more either of x or y

are preferred to less), the constraint can be simplified to px+ ry= p x d +r y d .

17.5. The Slutsky’s demand for x can therefore be gotten by solving from the Langrangian

α 1−α
L=x y −λ ( px+ ry− p x d +r y d ) , which gives the first order conditions for a maximum in

the context of our simple Cobb-Douglas function and this particular budget constraint.

17.6. The solution for x is

(
x=α x d +
r
y
p d ) Equation 8

17.7. Analogously, the Slutsky’s demand for y is y ( r , xd , y d )=( 1−α ) ( p

)
x +y .
r d d

18. Final note on monotonic transformations

18.1. Take into account that the Marshallian demand (as well as the Engel curve, wealth

expansion path, price expansion path, indirect utility function, Roy’s identity, Hicksian

demand, expenditure function, Sheppard’s lemma, Slutsky equation for a Hicksian demand,

Slutsky’s demand, and indifference curve) are all insensitive to monotonic transformations.

Last line

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