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

ENC 312, what have you learned from the class

what have you learned from the class

Var modelling, However, these results should be approached with due caution...

However, these results should be approached with due caution. The limitations and problems associated with VAR modelling have been outlined in this paper, therefore these observati

Gdp of various components, What are prices indexes designed to measure? Out...

What are prices indexes designed to measure? Outline how they are constructed. When GDP and other income figures are compared across time periods, explain why it is important to ad

Explain consumer price index, Q. Explain Consumer Price Index? CPI is a...

Q. Explain Consumer Price Index? CPI is a price index of a particular basket known as the CPI-basket. CPI-basket comprise essentially all the servicesand goods consumed in a co

What do you mean by capital flows, Q. What do you mean by Capital Flows? ...

Q. What do you mean by Capital Flows? With free capital flows, this is a very unreasonable assumption. If we domestic interest rate increase against the foreign interest rates,

Retirement planning, For retirement planning, you decided to deposit $1,000...

For retirement planning, you decided to deposit $1,000 per month and increase your deposit by $100 per month. How much will you have at the end of 10 years if the bank pays 3% annu

Describe wages and income, Q. Describe Wages and income? Remember that ...

Q. Describe Wages and income? Remember that by wage we characteristically mean what you receive for working one hour, whereas income is the total revenue from all sources over

Determine aggregate supply curve is vertical or not, Explain whether the fo...

Explain whether the following statements are true or false: a) The long run aggregate supply curve is vertical because economic forces do not affect long run aggregate supply.

IS and LM model, An economy shows the following features C=50+0.9(Y-T) T=1...

An economy shows the following features C=50+0.9(Y-T) T=100 I=100-5i G=100 L=0.2Y-10i M/P=100 X=20 M=10+0.1Y a)Obtain the IS and LM for this economy b)Find out the equilibrium inc

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