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

Controlling the supply of money, When the reserve requirement changes, whic...

When the reserve requirement changes, which of the following will change in the total banking system?  (Answer change or No Change) Transaction Deposits Total Reserves Req

Willing to hold money, Was money a better store of value in the United Stat...

Was money a better store of value in the United States in the 1950s than it was in the 1970s? Why or why not? In which period would you have been willing to hold money? Which one w

Inverse market supply curve, The inverse market demand curve for a good is ...

The inverse market demand curve for a good is p = 100? 0.25Q. the inverse market supply curve for the good is p = 20 + 0.55Q. Calculate the equilibrium price and quantity, consumer

Reaganomics, Reaganomics Supply-side economics or New Classical Econom...

Reaganomics Supply-side economics or New Classical Economics has gained distinct prominence in the early 1980s with the election in the U.S.A of a conservative government unde

Real wage, what wil hapen to the real wage if the nominal wages and prices ...

what wil hapen to the real wage if the nominal wages and prices rise at the same rate per year?

Estimate the length of pipe, Engineers sometimes add chlorine to pipes to d...

Engineers sometimes add chlorine to pipes to disinfect water. It is desired to achieve four logs of kill. This means that the effluent concentration of microorganisms is 10 -4 tim

Considering two types of water heaters, A company is considering two types ...

A company is considering two types of water heaters. The associated costs are shown below. The estimated annual cost of operation for oil heaters equals 365 x 41045/EF x Fuel Cost

What are the capitalist countries in the world, Capitalism is the dominant,...

Capitalism is the dominant, most used form of government there is in the globe today. Presently, over 80% of countries use capitalism and a free market economy.

Basic concepts and terminology, when domestic currency becomes more valuabl...

when domestic currency becomes more valuable in terms of foreign currency, the domestic currency is said to have

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