Optimization

with
Equality Constraints
 Utility Maximization
• Problems involving utility maximization are the most
common application of optimization with equality
constraints.

• The typical problem encountered involves the

maximization of utility subject to a budget constraint.

• Typically, only two goods are considered, but variants

involve n goods and intertemporal decisions, among
others. 2
 Utility Function with Two Goods
U

• In the typical example,

utility is a function of two
goods and therefore the
function can be visually X1
examined in three
X2
dimensions. U

X1
• Example:
–

X2 3
Utility Maximization and Indifference Curves
• Indifference curves are
levels of constant utility.

• Indifference curves are

also called level curves.

• In the typical case, as

we move up the “hill”
we move to a higher
level of utility.

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 Indifference Curves
• Economics typically examines the
consumer choice problem in two Higher levels
dimensions. of utility

• Indifference curves are the level

curves of constant utility viewed
from above.

• Because the 3-D map of the utility

function is viewed from above and
projected into two dimensions,
indifference curves are similar in
some ways to the altitude lines in a
topographical map: both show
constant levels.
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Utility Maximization with Budget Constraint
• Two good consumer
problem:

• The optimal bundle is where

the slope of the indifference
curve is tangent to the
budget constraint.

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 The Slope of an Indifference Curve
• The slope of an indifference curve is often referred to as the marginal rate
of substitution. It indicates the rate of change of good one for good two
that is required in order to stay at the same level of utility.

• Given U(X, Y), the marginal utility of good X and good Y are given by

= Marginal utility of good X

= Marginal utility of good Y
• The marginal rate of substitution is equal to the ratio of the two marginal
utilities. At the optimal point (X*, Y*) is given by:

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 Linear Budget Constraint

Slope of Budget Constraint

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 Budget Constraint General Case
• The budget constraint for two goods can be expressed as

• The partial derivatives of B with respect to x and y are given by:

• The slope of the budget constraint at the optimal point is give by:

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 Example
• Determine the slope of the budget constraint where

• Let

• The partial derivatives of H with respect to X and Y are given by:

• The slope of the budget constraint is a constant and is given by:

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 Optimal Bundle
• At the optimal point, the slope of the indifference
curve is equal to the slope of the budget constraint.

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 Two Solution Methods
Optimization with Equality Constraints
• The general approach for solving optimization
problems when the constraint holds with an equality
is to incorporate the constraint into the objective
function.

• Two solution methods

– Use substitution to directly incorporate the budget
constraint directly into the utility function.
– Lagrangian methods, which are generally preferred by
economists

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 Example
• Use the substitution technique to locate the
maximum level of utility given the constraint.

• Subject to

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 Solution - I
• The utility function and the constraint are respectively given by:

• We can solve equation (8b) for x.

• Plugging equation (8c) into equation (8a) gives

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 Solution - II
• The transformed objective function is given by:

• Given the above, the relevant first order condition is given by:

• Simplifying the above gives:

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 Solution - III
• Given the value for y , we can substitute it into the budget constraint to
solve for x.

• Recall the budget constraint is given by:

• Substituting in y gives:

• The optimal bundle is at (10,10)

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 The Lagrangian Function
• The Lagrangian technique creates a new objective function (the Lagrange)
which incorporates the original objective function and the constraint.

• Through incorporating one more variable (the Lagrange multiplier), the

Lagrange method transforms a constrained optimization problem into an
unconstrained optimization problem.

• The typical two good problem is presented below.

• Where,
– L(x, y, λ) is the Lagrange function
– λ is the Lagrange multiplier
– is the budget constraint
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 Lagrange Multiplier Interpretation
• The Lagrange multiplier can be interpreted as
the marginal utility of income.

• Thus, if the value of λ = 10, the level of utility

is estimated to increase by 10 if the consumer
has one additional dollar.

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 Example
• Use the Lagrange method to identify a point that
maximizes the value of the following function given
the constraint.

• Subject to

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 Solution - I
• The function we are maximizing and the constraint are respectively given by:

• The Lagrange function is thus given by

• The three first order conditions are given by:

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 Solution - II
• The three first order conditions are given by:

• Solving equations (11g) and (11h) for λ gives:

• Setting equations (11j) and (11k) equal to each other and solving for y gives:

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 Solution - III
• On the prior slide we discovered that
–

• The budget constraint is given by:

• Plugging equation (11n) into (11o) and solving for x gives:

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 Solution - IV
• Given we can solve for y and λ by successively.

• Plugging X into the budget constraint allows us to solve for y.

• These are the same values that we obtained with

substitution!

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 Solution - V
• We can also solve for the value of the Lagrange multiplier, λ, using one of
the first order conditions.

• Recall

• Plugging in the value for x and solving for λ gives:

• The marginal utility of income is 20.

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 Example
• A consumer with $30 has a utility function for wine
and cheese that is given by The price of wine is $6
per glass and for cheese it is $4 per slice.

• Assuming the consumer can purchase fractional

amounts, how many glasses of wine and slices of
cheese should she buy?

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 Solution - I
• The Lagrange function is given by:

• The three first order conditions are given by:

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 Solution - II
• The three first order conditions are

• Dividing equation (12e) by equation (12f) and then simplifying gives:

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 Solution - III
• To solve for the amount of wine she will purchase we can plug equation 12k into
the budget constraint.
–

• Simplifying and solving for W gives

• Plugging the solution for W into equation (12l) gives

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 Solution - IV
• We can solve for the value of the Lagrange multiplier by using a relevant first order condition.
Recall, these were given by:

• Plugging the values for W and C into equation (12q) and then simplifying gives:

• Simplifying further and solving for λ (the marginal utility of income) gives:

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 Solution - V
• We can check whether our solutions for W, C, and λ are correct by
plugging them into the first order conditions to determine if they balance.

• Plugging W = 1, C = 6, and λ = 0.1398 into each equation gives:

• Because each of the above first order conditions balance we know we

have determined the correct values for W, C and λ.

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