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General Equilibrium Theory 11 15
General Equilibrium Theory 11 15
CONSUMER THEORY 7
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
r2 U p
is invertible
pT 0
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
2.1.1 Duality
Let V : RL++ R+ ; V (p; m), be dened by
@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.
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