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

Trade unions, what reasons limit the bargaining power of trade union in dev...

what reasons limit the bargaining power of trade union in developing countries

Draw game in two standard forms, Consider the following game [payoffs are i...

Consider the following game [payoffs are in the form: (Ann, Bob, Carol)]: a) List each player's actions and strategies. b) If Ann "buys" Carol's position in the game (i.

Internal market forces, what are some internal market forces and how is the...

what are some internal market forces and how is the outcome of output, jobs, prices, growth, and international balance

Fiscal, what is the supply side

what is the supply side

Negative outflow to the u.s. balance, A negative outflow to the U.S. balanc...

A negative outflow to the U.S. balance of payments is generated by the purchase of United States assets (such as United States Treasury bonds) by foreign investors and the sale of

Partial equilibrium and surplus, The city of Cabernet is very famous for it...

The city of Cabernet is very famous for its production of wine. The inhabitants of the city have an aggregate demand for wine that can be described as follows: D(p) = Q d =150-

Estimating womens labor supply, 1.    Estimating Women's Labor Supply a....

1.    Estimating Women's Labor Supply a.    The following regression was run for an estimate of the current women's labor supply curve: Where h i = hours of labor suppl

International trade, developing countries benefit through international tra...

developing countries benefit through international trade from developed countries

Define gdp, A farmer grows a bushel of wheat & sells it to a miller for Rs....

A farmer grows a bushel of wheat & sells it to a miller for Rs. 1.00. The miller turns the wheat into flour & then sells the flour to a baker for RS. 3.00. The baker uses the f

Correlation of investment and interest rate, Suppose the demand for loanabl...

Suppose the demand for loanable funds was stable but the supply fluctuated from year to year. what cause fluctuate in supply?

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