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 p1x+ p2x2 = M  holds. Let initial indifference curve of the consumer is IC0. In IC0, there are many points along that indifference curve such that p1x+ 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 p1x+ 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 p1x+ 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

Perfect competition, c) Explain why perfectly competitive markets lead to a...

c) Explain why perfectly competitive markets lead to an allocatively efficient allocation of resources in the long run

Live around a hazardous waste dump, : Suppose that 100 people live around a...

: Suppose that 100 people live around a hazardous waste dump. If the people continue to live there for 20 years, one of them will likely contract a painful, non-fatal cancer that w

What is gdp, Assuming an economy with no government and no foreign trade. M...

Assuming an economy with no government and no foreign trade. Measure GDP for the following output scenario: There are three firms: firm A is a minning company, firm B is a stee

Traditional business cycle, casual factors of traditional business cycle an...

casual factors of traditional business cycle and its effects on the sectors of the economy

Find real interest rate and nominal interest rate, Assume that an economy's...

Assume that an economy's GDP Y=5000. Also assume that the government runs a deficit where tax revenue T=1000 and government expendituresG= 1500. The consumption function is represe

Estimate the wacc and cost of capital, Cowboy Corporation is estimating its...

Cowboy Corporation is estimating its WACC.  The firm's debt structure contains: (1) 30,100 long-term bonds with an 8.1% coupon, paid semiannually, a 10 years-to-maturity, and a $10

Determine elasticity of demand , Consider the consumption decisions of R.B....

Consider the consumption decisions of R.B. Turbo, a new student at T University. Ms. Turbo has only available $1,000 in monthly income to spend on food and housing. In te

Clasical model., if we impose any rule and regulation on clasical model lik...

if we impose any rule and regulation on clasical model like not expoit polutionso what is effect on factor of clasical model

What are between material and non-material progress, What are between mater...

What are between material and non-material progress? • Material progress considers to as economic growth. Growth is only one dimension of development. Growth doesn’t unavoidab

A good is classified as inferior, a good is classified as inferior if a....

a good is classified as inferior if a. consumers buy less when the price rises b. consumers buy less when the income rises c. consumers buy less when the price falls d.

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