Utility maximization problem: Difference between revisions

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In [[microeconomics]], the '''Utility Maximization Problem''' is the problem consumers face: ''how should I spend my money in order to maximize my [[utility]]?''

Suppose their [[consumption set]]

Suppose their [[consumption set]] <math>\textbf R^L_+</math> has L commodities. If the prices of the L commodities are <math>p \in \textbf R^L_+</math> and the consumer's wealth is w, then the set of all affordable packages, the [[budget set]] is <math>B(p, w) = \{x \in \textbf R^L_+ : p \cdot x \leq w\}</math>. The consumer would like to buy the best package of commodities it can afford. If <math>u : \textbf R^L_+ \rightarrow R</math> is the consumer's utility function, then the consumer's optimal choices x(p, w) are

:<math>x(p, w) = argmax_{x^* \intextbf B(p, w)} u(xR^*)L_+</math>.

has ''L'' commodities. If the prices of the ''L'' commodities are

Finding x(p, w) is the '''Utility Maximization Problem'''.

The solution x(p, w) need not be unique. If u is continuous and no commodities are free of charge, then x(p, w) is nonempty. Proof: B(p, w) is a [[compact space]]. So if u is [[continuous]], then the [[Karl Weierstraß|Weierstrass]] theorem implies that u(B(p, w)) is a compact subset of <math>\textbf R</math>. By the [[Heine-Borel theorem]], every compact set contains its maximum, so we can conclude that u(B(p, w)) has a maximum and hence there must be a package in B(p, w) that maps to this maximum.

:<math>p \in \textbf R^L_+</math>

If a consumer always picks an optimal package as defined above, then x(p, w) is called the [[Marshallian demand correspondence]]. If there is always a unique maximizer, then it is called the [[Marshallian demand function]]. The relationship between the [[utility function]] and [[Marshallian demand]] in the Utility Maximization Problem mirrors the relationship between the [[expenditure function]] and [[Hicksian demand]] in the [[Expenditure Minimization Problem]].

and the consumer's wealth is ''w'', then the set of all affordable packages, the [[budget set]], is

In practise, a consumer may not always pick an optimal package. For example, it may require too much thought. [[Bounded rationality]] is a theory that explains this behaviour with [[satisficing]] - picking packages that are suboptimal but good enough.

:<math>B(p, w) = \{x \in \textbf R^L_+ : p \cdot x \leq w\}</math>.

The consumer would like to buy the best package of commodities it can afford. If

:<math>u : \textbf R^L_+ \rightarrow R</math>

is the consumer's utility function, then the consumer's optimal choices ''x''(''p'', ''w'') are

:<math>x(p, w) = argmax_{x^* \in B(p, w)} u(x^*)</math>.

Finding ''x''(''p'', ''w'') is the '''Utilityutility Maximizationmaximization Problemproblem'''.

The solution ''x''(''p'', ''w'') need not be unique. If ''u'' is continuous and no commodities are free of charge, then x(p, w) is nonempty. Proof: ''B''(''p'', ''w'') is a [[compact space]]. So if ''u'' is [[continuous]], then the [[Karl Weierstraß|Weierstrass]] theorem implies that u(B(p, w)) is a compact subset of <math>\textbf R</math>. By the [[Heine-Borel theorem]], every compact set contains its maximum, so we can conclude that ''u''(''B''(''p'', ''w'')) has a maximum and hence there must be a package in ''B''(''p'', ''w'') that maps to this maximum.

If a consumer always picks an optimal package as defined above, then ''x''(''p'', ''w'') is called the [[Marshallian demand correspondence]]. If there is always a unique maximizer, then it is called the [[Marshallian demand function]]. The relationship between the [[utility function]] and [[Marshallian demand]] in the Utility Maximization Problem mirrors the relationship between the [[expenditure function]] and [[Hicksian demand]] in the [[Expenditure Minimization Problem]].

In practisepractice, a consumer may not always pick an optimal package. For example, it may require too much thought. [[Bounded rationality]] is a theory that explains this behaviour with [[satisficing]] - picking packages that are suboptimal but good enough.

==References==

Mas-Colell, Andreu; Whinston, Michael; & Green, Jerry (1995). ''Microeconomic Theory''. Oxford: Oxford University Press. ISBN 0195073401

[[Category:Microeconomics]]

[[Category:Optimization]]