You are on page 1of 5

2.1.

CONSUMER THEORY 7

Dene then the Slutsky matrix of compensated price eects as

S(p; m) = Dp x(p; m) + Dm xx:

WARP then implies the following.

Proposition 2 S(p; m) is negative semi denite; that is,

dpS(p; m)dp 0; for any dp 2 RL :

Finally, any solution of the consumers problem satises the following


system of Kuhn Tucker necessary and su cient conditions. In the case of
interior solutions, these are:

rU p = 0
m p x = 0;

for some > 0, the Lagrange multiplier associated to the budget constraint.
Local properties of x(p; m) can then be obtained using the Implicit Function
theorem on the previous rst order conditions (focs):

r2 U p dx 0
= dp + dm
pT 0 d xT 1

Note that the second order conditions (socs) guarantee that

r2 U p
is invertible
pT 0

when evaluated at an (x; ; p) satisfying focs. A simple proof of this state-


ment follows for completeness.
Proof. We show that @(y; z) 2 RL+1 , (y; z) 6= 0 such that

r2 U p y r2 U y pz
= = 0:3
pT 0 z py

3 r2 f rf
For any strict quasi concave and C 2 function f : RL
+ ! R; the matrix
rf T 0
2
r U p
is called bordered Hessian and has a non-zero determinant. Note that is
pT 0
the bordered Hessian of the Lagrangian.
8 CHAPTER 2. DEMAND THEORY: A QUICK REVIEW

By contradiction, suppose such a (y; z) exists. Then pre-multiplying r2 U y


pz by y, yields:
yr2 U y = ypz:
But ypz = 0; and hence yr2 U y = 0: But the second order conditions (socs;
in turn guaranteed by strict quasi-concavity of the Lagrangian, U (x) (px
m)), require that vr2 U v < 0 on all v 6= 0 such that (rU p) v = 0; a
contradiction.

2.1.1 Duality
Let V : RL++ R+ ; V (p; m), be dened by

V (p; m) = U (x(p; m)):

V (p; m) is the indirect utility function.

Proposition 3 The indirect utility function V (p; m) satises the following


properties:

@V (p; m)=@m = > 0: the consumers marginal utility of wealth equals the
shadow value of relaxing the budget constraint;
V (p; m) is homogenous of degree zero in p; m;
@V (p; m)=@pl 0 for all l; p >> 0;
V (p; m) is quasi-convex in p: the lower contour set p : V (p; m) V is
convex.

Proof. The properties are straighforward consequences of the assumptions


on U (x) and the properties of x(p; m): We leave them to the reader, except
quasi-convex in p; which is proved as follows. Take any pair p0 ; p00 such that
V (p0 ; m); V (p00 ; m) V and consider p^ = p0 + (1 )p00 for 2 [0; 1]. Note
that for all x such that p^ x m we must have either p0 x m and/or
00
p x m; thus U (x) v .
Consider the consumers cost minimization problem,

min p x
x2X
s.t:U (x) u
2.1. CONSUMER THEORY 9

A solution exists for all u U (0) and p 2 RL++ : The solution h(p; u); with
h : RL++ R ! RL+ ; is typically referred to as compensated - or Hicksian -
demand. By the socs,
Dp h(p; u) is symmetric, negative semi-denite.
We say that Hicksian demands h(p; u) satisfy the law of demand.
Let e : RL++ R ! R+ ; e(p; u) = p h(p; u) dene the expenditure function.
Proposition 4 The expenditure function e(p; u) has the following properties:
@e(p; u)=@u > 0;
@e(p; u)=@pl 0 for all l = 1; ::; L;
e(p; u) is homogeneous of degree one in p;
e(p; u) is concave in p:
Proof. The properties are straighforward consequences of the Maximum
theorem and the assumptions on U (x). We leave them to the reader, except
quasi-concavity in p; which is proved as follows. For any pair p0 ; p00 , consider
p^ = p0 + (1 )p00 for 2 [0; 1]. Then, for any u, e(^ p; u) = p^ h(^ p; u) =
0
p h(^p; u) + (1 )p00 h(^
p; u); which is in turn e(p0 ; u) + (1 )e(p00 ; u):

For all p 2 RL++ , m > 0; u > U (0), the following identities hold:
x(p; m) = h(p; u)
(2.1)
for u = V (p; m) and e(p; u) = m:
By the envelope theorem, the compensated demand can be obtained from
the expenditure function:
h(p; u) = Dp e(p; u):
Hence the properties of h(p; u) can also be obtained from those of e(p; u).
Similarly, dierentiating the equation dening the indirect utility,
V (p; m) = U (x(p; m) (px m)
with respect to p, we obtain Roys identity:
rp V (p; m) = x(p; m) = rm V (p; m) x(p; m):
A brief summary of the duality relationships can be helpful:
10 CHAPTER 2. DEMAND THEORY: A QUICK REVIEW

Figure 2.1: Brief summary of duality relations


2.1. CONSUMER THEORY 11

x(p; m) ! h(p; u) Slutsky:

Dp x(p; u) Dm x xT = Dp h(p; u):

V (p; m) ! x(p; m) Roys identity:


1
x(p; m) = rp V (p; m):
rm V (p; m)

e(p; u) ! h(p; u) Expenditure function properties:

h(p; u) = rp e(p; u):

V (p; m) $ e(p; u) Utility-expenditure duality, for given p 2 RL++ :

V (:; m) = e 1 (:; m);


e(:; u) = V 1 (:; u)

x(p; m) $ h(p; u) Marshallian-Hicks demand duality:

x(p; m) = h(p; V (p; m))


h(p; u) = x(p; e(p; u))

2.1.2 Aggregate demand


It is useful to study in detail the properties of aggregate demand, as a func-
tion of wealth. With some abuse of notation, let introduce the notation to
index agents, i = 1; :::; I. Let the wealth of agent i be denoted mi : Fix the
distribution of wealth as follows,
X
mi = i m for some given i 0, for all i, i
= 1:
i

The Marshallian demand of any agent i is then denoted xi (p; mi ) and


X
x(p; m) = xi (p; mi )
i2I

is the aggregate demand.

You might also like