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41 views

Week 4

Uploaded by

Trinanti Avina
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© © All Rights Reserved
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Teori Mikroekonomi 1

Week 4
PROGRAM PASCASARJANA ILMU EKONOMI 2020/2021
QISHA QUARINA
CONSUMER’S EXPENDITURE MINIMIZATION

REF: NICHOLSON & JEHLE

Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.


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Expenditure Minimization
Dual minimization problem for utility maximization
◦ allocating income in such a way as to achieve a given level of utility with the minimal
expenditure
◦ this means that the goal and the constraint have been reversed

3
Expenditure Minimization
• Point A is the solution to the dual problem
Expenditure Minimization
The individual’s problem is to choose x1,x2,…,xn to minimize

total expenditures = E = p1x1 + p2x2 +…+ pnxn


subject to the constraint

utility = U1 = U(x1,x2,…,xn)
The optimal amounts of x1,x2,…,xn will depend on the prices of the goods and
the required utility level

6
Expenditure Function
The expenditure function shows the minimal expenditures necessary to
achieve a given utility level for a particular set of prices

minimal expenditures = E(p1,p2,…,pn,U)


The expenditure function and the indirect utility function are inversely related
◦ both depend on market prices but involve different constraints

7
Two Expenditure Functions
The indirect utility function in the two-good, Cobb-Douglas case is

I
V ( p x , py , I ) =
2 px0.5 py0.5

• If we interchange the role of utility and income (expenditure), we will


have the expenditure function

E(px,py,U) = 2px0.5py0.5U

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Two Expenditure Functions
For the fixed-proportions case, the indirect utility function is

I
V ( p x , py , I ) =
px + 0.25 py
• If we again switch the role of utility and expenditures, we will have the
expenditure function

E(px,py,U) = (px + 0.25py)U

10
Exercise
From the following Cobb-Douglas utility function
𝑈(𝑋1 , 𝑋2 ) = 𝑋1 ∝ 𝑋2 𝛽
Where ∝ = 𝛽 = 0.5
Find:
1. the Hicksian Demand
2. the Expenditure Function
Properties of Expenditure Functions

13
Concavity of Expenditure Function
Exercise
Proof each of the property of Expenditure Function!
Duality
Duality
Duality
Consumer Duality
Substitute cost function to Marshalian demand function then you’ll find the HICKSIAN
Demand Function
Consumer Duality
Substitute indirect utility function into hicksian demand function then you’ll find the
MARSHALLIAN Demand Function
Consumer Duality
You can also work backward, by differentiating Indirect utility function respect to p and divided it with
differentiating Indirect utility function respect to m then you’ll get the MARSHALLIAN Demand
Function. We call it “Roy’ Identity”
Consumer Duality
You can also work backward, by differentiating cost function respect to p then you’ll obtain the
HICKSIAN Demand Function→ “Hotelling/Shepard Lemma”
Exercise
1. Proof Theorem 1.8-1.9 using Cobb-Douglas Utility Function!
2. Using a Cobb-Douglas Utility Function, find:
- Expenditure Function
- Hicksian Demand from the expenditure function using Sheppard’s
Lemma
Important Points to Note:
To reach a constrained maximum, an individual should:
◦ spend all available income
◦ choose a commodity bundle such that the MRS between any two goods is equal to the ratio of the
goods’ prices
◦ the individual will equate the ratios of the marginal utility to price for every good that is actually consumed

Tangency conditions are only first-order conditions


◦ the individual’s indifference map must exhibit diminishing MRS
◦ the utility function must be strictly quasi-concave

Tangency conditions must also be modified to allow for corner solutions


◦ the ratio of marginal utility to price will be below the common marginal benefit-marginal cost ratio for
goods actually bought

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Important Points to Note:
The individual’s optimal choices implicitly depend on the parameters of his budget constraint
◦ choices observed will be implicit functions of prices and income
◦ utility will also be an indirect function of prices and income

The dual problem to the constrained utility-maximization problem is to minimize the expenditure
required to reach a given utility target
◦ yields the same optimal solution as the primary problem
◦ leads to expenditure functions in which spending is a function of the utility target and prices

26
Online source that might help
Properties of expenditure Function:
1. https://www.youtube.com/watch?v=HCANzswyhis
2. https://www.youtube.com/watch?v=ZcTGlUuQdTs

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