Marshallian Demand Functions : Some Examples

i Fixed Coecients
If the utility function is
u(x) = min(ax
1
, bx
2
)
then either u/x
1
= 0 ( if ax
1
> bx
2
), or u/x
2
= 0 ( if ax
1
< bx
2
), or the utility function is not
dierentiable ( if ax
1
= bx
2
).
If the price of each good is positive, then the consumers optimal choice of consumption bundle x

(p
1
, p
2
, M)
must be located at the kink in the L-shaped indierence curve, at which ax
1
= bx
2
. [Why? If ax
1
> bx
2
,
for example, then the rstorder conditions would be u
1
= 0 = p
1
and u
2
= b = p
2
: the rst condition
says = 0 and the second condition says > 0. Or, more intuitively, why waste money on good 1, when
added consumption of the good does not make you any better o? ]
So the Marshallian demands satisfy the condition ax
1
= bx
2
, and the budget line equation p
1
x
1
+p
2
x
2
=
M. The rst condition says that
x
2
=
a
b
x
1
Substituting this denition in the equation of the budget line,
p
1
x
1
+ p
2
a
b
x
2
= M
or
x
1
=
b
p
1
b + p
2
a
M
which is the Marshallian demand function for good # 1. Therefore the Marshallian demand function for
good #2 is
x
2
=
a
p
1
b + p
2
a
M
ii Perfect Substitutes
If
u(x) = a
1
x
1
+ a
2
x
2
+ a
n
x
n
then
u
x
i
= a
i
for each good i. The marginal rate of substitution between any two goods i and j is a
i
/a
j
, which is a
constant, independent of the quantities consumed of the goods. The indierence curves between any two
goods are straight lines. Mathematically, the rstorder conditions
u
x
1
= a
1
= p
1
and
u
x
2
= a
2
= p
2
could both hold only if a
1
/a
2
= p
1
/p
2
, which would happen by coincidence. Usually, the consumer will
choose to be at a corner solution, spending all her money on the good i for which a
i
/p
i
is highest. That is,
if
a
1
/p
1
> a
2
/p
2
> a
n
/x
n
1
for example, then she will choose
x
1
=
M
p
1
and x
i
= 0 for every i > 1. Those would be her Marshallian demands. Only if there was a tie, so that, for
example
a
1
p
1
=
a
2
p
2
>
a
3
p
3
>
a
n
p
n
would she choose to consume positive quantities of more than one good. In this case, the slope of her
indierence curve between x 1 and x
2
equals the slope of her budget line. Her Marshallian demands are
not unique : any (x
1
, x
2
, x
3
, . . . , x
n
) with p
1
x
1
+ p
2
x
2
= M, and x
3
= x
4
= = x
n
= 0 would be tied for
most preferred among the bundles which she could aord.
iii QuasiLinear Preferences
(iii a) u(x
1
, x
2
, x
3
) = x
1
+ 2

x
2
+ lnx
3
In this case, the three rstorder conditions are
1 = p
1
(1)
1

x
2
= p
2
(2)
1
x
3
= p
3
(3)
Equation (1) can be used to substitute for in equations (2) and (3) :
1

x
2
=
p
2
p
1
(2

)
1
x
3
=
p
3
p
1
(3

)
which can be rearranged into
x
2
= (
p
1
p
2
)
2
(2

)
x
3
=
p
1
p
3
(3

)
which are the Marshallian demand functions for goods #2 and #3.
Since
x
1
=
M p
2
x
2
p
3
x
3
p
1
therefore
x
1
=
M
p
1

p
1
p
2
1
is the Marshallian demand function for good #1. This expression is only correct if the persons income M
is high enough so that M > (p
1
)
2
/p
2
p
1
; otherwise x
1
would be negative. [ left to the reader : what
would Marshallian demands be if income M were lower than this? ]
In this example, the quantities demanded of goods 2 and 3 were independent of the persons income
M. Increases in income are all spent on good #1. This property holds whenever a person has quasilinear
preferences. If
u(x) = x
1
+ f(x
2
, x
3
, . . . , x
n
)
2
then the rstorder conditions to the consumers utility maximization problem are
1 = p
1
f
x
i
= p
i
i = 2, , n
If the rst equation is used to substitute 1/p
1
for in the remaining n 1 equations, then the rstorder
conditions for x
2
, x
3
, . . . , x
n
are n 1 equations in the n 1 unknowns x
2
, x
3
, . . . , x
n
. That means they can
be solved without reference to the budget condition, or to the income level M. This property holds only if
preferences are quasilinear.
(iii b) u(x
1
, x 2, x
3
) = x
1
+ lnx
2
+ ln(x
2
+ x
3
)
Here the rstorder condition on x
1
again implies that
=
1
p
1
so that the other two rstorder conditions can be written
1
x
2
+
1
x
2
+ x
3
=
p
2
p
1
(2)
1
x
2
+ x
3
=
p
3
p
1
(3)
Substitution of equation (3) into equation (2) yields
1
x
2
=
p
2
p
1

p
3
p
1
(2

)
or
x
2
=
p
1
p
2
p
3
(2

)
which is the Marshallian demand function for good #2. Since equation (3) can be written
x
2
+ x
3
=
p
1
p
3
(3

)
then equation (2

) implies that
x
3
=
p
1
(p
2
2p
3
)
p
3
(p
2
p
3
)
(3

)
which is the Marshallian demand function for good #3. Substitution into the budget constraint then implies
x
1
=
M
p
1
2
is the Marshallian demand function for good #1. These demand functions are only valid when M > 2p
1
and
when p
2
> 2p
3
. [ left to the reader : what happens when these inequalities are not satised? ]
Here quantity demanded of good #3 depends on all three prices : but quasilinearity implies that
quantity demanded of good #2 and of good #3 is independent of income M.
iv CobbDouglas Preferences
If
u(x
1
, x
2
, . . . , x
n
) = x
a
1
1
x
a
2
2
x
a
n
n
3
then it is simplest to use the monotonic transformation U(x) = ln[u(x)] to get
U(x) = a
1
lnx
1
+ a
2
lnx
2
+ a
n
lnx
n
Firstorder conditions are now
a
i
x
i
= p
i
i = 1, , n
These equations can then be written
p
i
x
i
=
a
i

i = 1, , n
From the budget constraint
p
1
x 1 + p
2
x
2
+ p
n
x
n
=
a
1
+ a
2
+ a
n

= M
so that
1

=
M
a
1
+ a
2
+ a
n
Substituting back in the original rstorder conditions,
x
i
=
a
i
a
1
+ a
2
+ + a
n
M
p
i
i = 1, 2, , n
which are the Marshallian demand functions in this case. With CobbDouglas preferences, quantity de-
manded of each good does depend on income M : in fact quantity demanded of each good is proportional to
income. But quantity demanded of each good depends only on the price of that good, and not on the prices
of any of the other goods. In this case, the proportion of her income that the person spends on good i,
p
i
x
i
M
equals
a
i
a
1
+ a
2
+ a
n
which is a constant independent of income and of all the prices. If a person had CobbDouglas preferences,
then the proportion of her income which she spent on food, or on housing, would depend only on her tastes,
and would not change with her income, or with the prices of food or housing.
v CES Preferences
Done in the textbook.
vi StoneGeary Preferences
For simplicity, I choose the utility function
U(x) = b
1
ln(x
1
s
1
) + b
2
ln(x
2
b
2
) + + b
n
ln(x
n
s
n
)
with
b
1
+ b
2
+ + b
n
= 1
The rstorder conditions are
b
i
x
i
s
i
= p
i
i = 1, 2, , n
or
p
i
x
i
= p
i
s
i
+
b
i

4
Using the budget constraint p
1
x
1
+ p
2
x
2
+ p
n
x
n
= M and the fact that the b
i
s sum to 1, therefore
M =
n

j=1
p
j
s
j
+
1

so that
1

= M
n

j=1
p
j
s
j
which means that
x
i
= s
i
+
b
i
p
i
[M
n

j=1
p
j
s
j
]
is the Marshallian demand function for good #i. These demand functions are only valid if the person has
enough income to pay for her required consumption levels s
i
: if M

n
j=1
p
j
s
j
.
5