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

The short-run macroeconomic equilibrium, The figure below defines an econom...

The figure below defines an economy's aggregate demand curve and its short-runand long-run aggregate supply curves (labelled AD, SRAS, and LRAS, respectively). practically,the econ

Unemployed individual decides to spend the day fishing, 1. An unemployed in...

1. An unemployed individual decides to spend the day fishing. The opportunity cost of fishing is equal to A) The cost of bait and any other monetary expenses. B) Zero, becaus

How do countries grow economic growth, How do countries grow Economic growt...

How do countries grow Economic growth? Economic growth is attaining by increasing: • Quantity of resources by investment • Quality of resources by training as well as R

Budget, what are the function of budget

what are the function of budget

Variables are discrete, Which of these variables are discrete and which are...

Which of these variables are discrete and which are continuous random variables? a) The number of new accounts established by a salesperson in a year. b) The time between customer

Determination of price level, P and Y are both endogenous variables and acc...

P and Y are both endogenous variables and according to the quantity theory of money we need P.Y = constant. If we divide both sides by P we get Y = constant / P. Because Y = Y D i

Main causes of inflation in an economy, Question 1: Differentiate betwe...

Question 1: Differentiate between income, price and cross elasticities of demand. How will the concept of price elasticity be useful to the owner of a supermarket who wan

Introduction of Macroeconomics, Macroeconomics We have explained severa...

Macroeconomics We have explained several concepts and Macroeconomic Aggregates which form the basic terminology of macroeconomic analysis. Like other empirical sciences, econom

What is money has nothing to do with token itself, What is money has nothin...

What is money has nothing to do with token We also consider that what is money has nothing to do with token or commodity itself: USD is money in United States but not in

Explain about price inflation, Q. Explain about Price Inflation? The ma...

Q. Explain about Price Inflation? The major reason for allowing for non-constant wages in the model is that we then can allow for persistent deflation/inflation. With constant

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