Utility maximisation - graphical presentation , Macroeconomics

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.   

Posted Date: 10/26/2012 2:55:52 AM | Location : United States

Related Discussions:- Utility maximisation - graphical presentation , Assignment Help, Ask Question on Utility maximisation - graphical presentation , Get Answer, Expert's Help, Utility maximisation - graphical presentation Discussions

Write discussion on Utility maximisation - graphical presentation
Your posts are moderated
Related Questions
What is Gross National Product? Gross National Product (GNP): It measures the value of output produced through a country is citizens anywhere within the world, in a speci

What is Cost-push inflation Cost-push inflation takes place when costs of production increase causing short-run aggregate supply curve to shift to left. The main causes of c

what are the qualitative methods of controling credit

For an interest rate of 12% per year compounded continuously, find (a) the nominal rate per year, (b) the nominal rate per quarter, (c) the effective rate per quarter, and (d) the

Bruno's Lunch Counter is expanding and expects operating cash flows of $26,000 a year for 4 years as a result. This expansion requires $39,000 in new fixed assets. These assets wil

Why a perfectly competitive retail market is more competitive than a monopoly

In a large open economy, if the economy has a fiscal expansion, what would happen in the solow model?

Why are Economic Models uses for Trade-offs and Trade? Simplified representations of actuality a. production possibility frontier b. comparative advantage c. circular-

Consumer Prices Index Two economic indices learnt at AS are the Consumer Prices Index (CPI) and the Retail Prices Index (RPI). Both are used to calculate the average price lev

An investment promised a payoff of $195 two and a half years from today. At a discount rate of 75% per year what is the present value of this investment? A. 169.47 B. Not enoug