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Chapter 4

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Department
Economics
Course
Economics 2150A/B
Professor
Prof
Semester
Fall

Description
P a g e | 1 Part 2 Utility maximization subject to an income constraint is equivalent to expenditure minimization subject to a utility constraint. 1. In the utility maximization method for finding the optimal consumption bundle, we choose the bundle that allows us to reach the highest level of utility U subject to an income constraint. 2. Likewise, the consumer can choose a level of consumption of X and Y that minimizes expenditure on the two goods subject to a constraint that utility must be at least as high as the a certain utility level, say U=U2. Exogenous: U=U2, Px, Py Endogenous: X, Y, and Expenditure (I) Think of shifting the budget constraint inward to lower income levels until the expenditure line is just tangent to the given utility curve U=U*. This is the optimal consumption bundle. Examples of optimization with different budget constraints *Be able to draw and label the budget constraints in these examples. When analyzing public policy it is often easiest to think of the consumer consuming the good of interest and a composite good H with a price of 1 dollar. Composite good: represents expenditure on all other goods and has a price set at $1.00. If the composite good is on the vertical axis, then the y-intercept of the budget constraint represents both the quantity of the composite good purchased and total income. a. Coupons versus Cash subsidies Composite good, no housing subsidy NOTE: with the composite good y on the y axis 1. sl
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