Utility maximisation - graphical presentation , Macroeconomics

Assignment Help:

Utility Maximisation:

Graphical Presentation 

Let consider a two-commodity world, x1 and x2 representing good I and good II respectively. p1 and p2 are the prices of good I and good II respectively, where the prices are given to the consumer, i.e., prices are exogenously given and consumer can't change them. Money income of the consumer is M, which is also exogenously given to the consumer. Note that p1x1+p2x2 is the total expenditure of the consumer when she consumes x1units of good I and x2 units of good two. The total expenditure of the consumer can't exceed her money income, therefore  p1x1 + p2x2 ≤ M  ------- (a)  

Equation (a) is known as consumer budget constraint. Let U = U(x1, x2) is the utility function of the consumer. Therefore, consumer must solve the following Maximisation problem(UMP):   

709_Utility Maximisation.png

As consumer objective is to maximise her utility and as larger consumption leads to larger utility, she always wants to consume more of any goods. But she also has to spend some amount of her income to consume larger amount of goods. So ultimately in equilibrium she will spend all her income and M = p1x1+p2x2.  

Consumer Behaviour  Now suppose that the line segment AB represents the budget line. Along AB p1x1 + p2x2 = M  holds. Let initial indifference curve of the consumer is IC0. In IC0, there are many points along that indifference curve such that p1x1 + p2x2 ≤ M holds. Therefore, utility maximising consumer will spend more as she moves to higher indifference curve (say IC1). In IC1 there are still such points along the indifference curve such that p1x1 + p2x2 ≤ M  holds, so again consumer spends more. This process will continue as long as consumer reaches an indifference curve where for no point along the indifference curve p1x1 + p2x2 ≤ M holds and at least one point of the indifference curve is on the budget line. At that point, we have consumer equilibrium, C(x1, x2) = (x1*(M,p1,p2), x2*(M,p1,p2))(in Figure point 'e' is the equilibrium point). Not that at equilibrium, slope of the indifference curve is equal to the slope of the budget line. Therefore, at equilibrium we have 

1) Budget constraint holds with equality sign. 

2) Slope of the indifference curve is equal to the slope of the budget line.   


Related Discussions:- Utility maximisation - graphical presentation

Concept of growth and growth rate, The Concept of Growth and Growth Rate is...

The Concept of Growth and Growth Rate is explained below: Economic growth is rise in an economy’s level of the production of commodities, output or income. We can talk about th

Why gdp is determined only by aggregate demand, Q. Why GDP is determined on...

Q. Why GDP is determined only by aggregate demand? Note that we haven't said anything about the aggregate supply so far. In order to justify why GDP is determined only by aggre

Archery instructors need a license, Now suppose that the archery instructor...

Now suppose that the archery instructors need a license in order to charge for archery lessons. The license is free of charge, but there are only four licenses distributed. Assumin

Per year interest rate, For an interest rate of 12% per year compounded con...

For an interest rate of 12% per year compounded continuously, find (a) the nominal rate per year, (b) the nominal rate per quarter, (c) the effective rate per quarter, and (d) the

Nursing home can experience before it begins to lose money, A nursing home ...

A nursing home contracts with an HMO for skilled nursing care at $2.00 PMPM. If costs are expected to average $120 per day, what is the maximum utilization of days per 1,000 member

Expected profit or loss for the university, The enrollment in a course offe...

The enrollment in a course offered by the College of Business is random and is described by the following probability distribution: there is a 9% chance of 18 students, 22% chance

Negative outflow to the u.s. balance, A negative outflow to the U.S. balanc...

A negative outflow to the U.S. balance of payments is generated by the purchase of United States assets (such as United States Treasury bonds) by foreign investors and the sale of

Unions, Are unions “harmful monopolies” or "necessary?" compare and contras...

Are unions “harmful monopolies” or "necessary?" compare and contrast the schools of thought that subscribe and their point of views?

The effect of market for milk, 1a. Show on the market for milk the effect o...

1a. Show on the market for milk the effect of the introduction of BGH (bovine growth hormone). 1b. Show on the market for cheese the impact of what happened in the milk market.

Impact of transaction costs, Assess the impact of transaction costs as they...

Assess the impact of transaction costs as they apply to the Coase Theorem. Evaluate how government assignment of property rights impacts free market exchanges.

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd