Marshellian demand and the solution problem of maximizing Utility.

Marshellian demand and the solution problem of maximizing Utility.

Model construction- Maximizing the UTILITY

$B$ is the feasible set as it indicates that the expenditure not exceed income:
B = { x ∣ x ∈ R + n , p ⋅ x ≤ y } B=\{\mathbf{x}|\mathbf{x}\in\mathbb{R}_+^n,\mathbf{p}\cdot\mathbf{x}\leq y\} B={x∣x∈R+n​,p⋅x≤y}
As in a considerable size market, the prizes or goods are settle down and the disturb of a single consumer to it is too small to change it, so the change of the demand of goods depends on the change of the income($y$) and the solution to the problem of maximizing consumer’s utility.

And the problem of maximizing utility within the feasible set is supposed to be like:
$$\underset{\mathbf{x}\in {\mathbb{R}}_{+}^n}{\max }u(\mathbf{x})\text{s.t.}\mathbf{p}\cdot \mathbf{x}\le y$$

Solve the problem- Example- Marshellian demand

Utility function(Direct) with a constant elasticity of substitution(CES):
$$\underset{\mathbf{x}\in {\mathbb{R}}_{+}^n}{\max }u(\mathbf{x})=(x_1^{\rho }+x_2^{\rho }{)}^{1/\rho }\text{s.t.}\mathbf{p}\cdot \mathbf{x}=p_1{x}_1+p_2{x}_2\le y$$
Lagrange method is used here to solve the equation:
$$L(x_1,x_2,\lambda )\equiv (x_1^{\rho }+x_2^{\rho }{)}^{1/\rho }+\lambda (y-p_1{x}_1-p_2{x}_2)$$
Considering the first-order derivative of the lagrange function equal to $0$, we obtain:
$$\begin{array}{r}\{\begin{array}{rcl}& \frac{\partial L}{\partial x_1}=(x_1^{\rho }+x_2^{\rho }{)}^{(1/\rho )-1}{x}_1^{\rho -1}-\lambda p_1=0& (5a)\\ & \frac{\partial L}{\partial x_2}=(x_1^{\rho }+x_2^{\rho }{)}^{(1/\rho )-1}{x}_2^{\rho -1}-\lambda p_2=0& (5b)\\ & \frac{\partial L}{\partial \lambda }=y-p_1{x}_1-p_2{x}_2=0& (5c)\end{array}\end{array}$$
Combine equation (5a) with (5b), we get $\frac{x_1^{\rho -1}}{x_2^{\rho -1}}=\frac{p_1}{p_2}={\frac{x_1}{x_2}}^{\rho -1}$ , that’s the relation between $x_1,x_2$, then we just put it to the equation (5c) and get the solution of $x_1,x_2$ as follows:
$$\{\begin{array}{r}{x}_1=x_1(\mathbf{p},y)=\frac{p_1^{1/\rho -1}y}{p_1^{(\rho /\rho -1)}+p_2^{\rho /(\rho -1)}}\\ x_2=x_2(\mathbf{p},y)=\frac{p_2^{1/\rho -1}y}{p_1^{(\rho /\rho -1)}+p_2^{\rho /(\rho -1)}}\end{array}$$
Set the other prices and the income constant, then we get the relation between the demand and price of a goods $x_1$, that is the Marshellian demand of goods.

Indirect utility function

The reason why the direct utility function is direct lies on its illustration of the relation between values of utility and the amounts $\mathbf{x}$. The equation contains directly the amounts of goods $\mathbf{x}=[x_1,...,x_n]$.

For an indirect utility function, we substitute $x_i=x_i(\mathbf{p},y)$ for the direct expression of $x_i$ and the equation then contains $<\mathbf{p},y>$, and that is why the transformed equation is called indirect.

So the variables for an indirect utility function are $\mathbf{p}$ and $y$, we use $\upsilon (\mathbf{p},y)$ to carry the expression:
$$\upsilon (\mathbf{p},y)=[(x_1(\mathbf{p},y){)}^{\rho }+(x_2(\mathbf{p},y){)}^{\rho }{]}^{1/\rho }$$
Simplify the expression by introducing $r=\rho /(\rho -1)$:
$$\upsilon (\mathbf{p},y)=y(p_1^r+p_2^r{)}^{-1/r}$$

The Roy’s Identity

The indirect utility function has stated the relation between utility and $<\mathbf{p},y>$, thus we have got two dimensions from where we can look into the change of the utility.

The function$\upsilon (\mathbf{p},y)$ has two variables which meets $y=\mathbf{p}\cdot \mathbf{x}$.

The partial differential of $\upsilon (\mathbf{p},y)$ over $y$, $\frac{\partial \upsilon }{\partial y}$, indicates the increment of the utility considering the change of income $y$.

Substitute $y$ for $\mathbf{px}$, the partial differential could be written as:
$$\frac{\partial \upsilon (\mathbf{p},y)}{\partial (\mathbf{px})}$$
Considering the inverse effect of changing $\mathbf{p}$ and $y$ on utility, we have:
$$\frac{\partial \upsilon (\mathbf{p},y)}{\partial (\mathbf{px})}=-\frac{\partial \upsilon (\mathbf{p},y)}{\partial (\mathbf{y})}$$
that is:
$$\frac{\partial \upsilon (\mathbf{p},y)}{\partial (\mathbf{p})}=-\mathbf{x}\frac{\partial \upsilon (\mathbf{p},y)}{\partial (\mathbf{y})}$$
set the prices and amounts of goods other than $x_i$ constant, we rewrite the equation as follows:
$$\frac{\partial \upsilon (\mathbf{p},y)}{\partial ({\mathbf{p}}_{\mathbf{i}})}=-{\mathbf{x}}_{\mathbf{i}}\frac{\partial \upsilon (\mathbf{p},y)}{\partial (\mathbf{y})}$$
That is the Roy’s Identity and the other form is:
$${\mathbf{x}}_{\mathbf{i}}=-\frac{\partial \upsilon (\mathbf{p},y)/\partial ({\mathbf{p}}_{\mathbf{i}})}{\partial \upsilon (\mathbf{p},y)/\partial (\mathbf{y})}$$
which also illustrates how we get Marshellian demand from the indirect utility function.