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

Pros and cons of commercial transactions, Examine the pros and cons of comm...

Examine the pros and cons of commercial transactions in blood from the egoistic, the utilitarian, and the Kantian perspectives

How firm produce an output, A firm sells its product in a perfectly competi...

A firm sells its product in a perfectly competitive market where other firm charges a price of $90 per unit. The firm's total costs are C(Q) = 50 + 10Q + 2Q2. How much output shoul

Number of gallons of pain, The number of gallons of paint that Home Depot s...

The number of gallons of paint that Home Depot sells in a given day is normally distributed with a mean of 150 gallons and a standard deviation of 35 gallons (I realize that the di

Intergroup conflict and intergroup competition, Discuss whether intergroup ...

Discuss whether intergroup conflict and intergroup competition are the same or different. Provide examples to support your position. What strategies can a leader use to ensure that

Two-way anova., A scientist has been studying the organisms colonising the ...

A scientist has been studying the organisms colonising the pilings underneath a wharf in Sydney Harbour. He postulates two factors might make these communities of sponges, worms, a

Pareto optimality, Diagramatic explanation of pareto optimality

Diagramatic explanation of pareto optimality

Anti-trust legislation, Explain why anti-trust legislation supports a perfe...

Explain why anti-trust legislation supports a perfectly competitive market. Give at least one specific example of legislation to justify your explanation.

Employ the weights, Employ the weights given below and suppose that 2002 is...

Employ the weights given below and suppose that 2002 is the base year with a CPI equal to 100. Suppose also that since 2002 the price of food has increased by 10 percent; the price

Equilibrium price of guitars, Suppose the demand for guitars in State Colle...

Suppose the demand for guitars in State College is given by Qd = 9000 - 12P where Qd is the quantity demanded, and P is the price of guitars. Also, suppose the supply of guitars is

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