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

Payment toward its bank loan, During the year, Calabash Clinic made a $50,0...

During the year, Calabash Clinic made a $50,000 cash payment toward its bank loan which it had previously recorded; $40,000 was for principal, and $10,000 was to pay the full amoun

Determine the cross elasticity demand for margarine, Question 1: (a) D...

Question 1: (a) Distinguish between the short run and long run profits of a competitive firm by using graphical representations. (b) Compare and contrast between perfect c

Calculate the equilibrium price, Assume a market with demand Q = 16p^(--2) ...

Assume a market with demand Q = 16p^(--2) that is supplied by a monopoly with costs C(Q) = 6 + Q2/8. 1. Calculate the equilibrium price, output and monopoly profits. 2. What

Interest rates, Interest Rates (R) - I feel that it is important to include...

Interest Rates (R) - I feel that it is important to include a variable which represents the monetary sector of the economy because those inflationary pressures which are expected t

Firm''s output at various levels of employment, Use the following data for ...

Use the following data for a firm's output at various levels of employment (L) to calculate: a) its marginal physical product of labor (MPPL) schedule; (b) its (MPPL/MRCL) schedule

What is quantitative easing, What is Quantitative easing Quantitative ...

What is Quantitative easing Quantitative easing (QE) is an unorthodox monetary policy which since 2009 has been intermittently pursued by Bank of England and US Federal Reserv

Enumerate the categories of firms in the circular flow, Firms in the circul...

Firms in the circular flow We divide all firms into 3 categories: F R comprises all firms which acquire raw material (farm products, iron ore and so on), F H all those that p

Paper mill and downstream box mill, Suppose that a paper mill "feeds " a d...

Suppose that a paper mill "feeds " a downstream box mill. For the downstream mill, the marginal profitability of producing boxes declines with volume. For example, the first unit o

What are the comparative benefits, What are the comparative benefit The...

What are the comparative benefit The idea of comparative benefit defines that a nation must specialise in the industries in which it has a comparative advantage. Comparative be

What is the total cost of producing output, What is the total cost of produ...

What is the total cost of producing output? The total cost of producing a specified quantity of output is the total of the fixed cost along with the variable cost of producing

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