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Consumer Theory with BurkeyAcademy www.burkeyacademy.com © Mark L. Burkey

Hicksian (Compensated) Demand

Marshallian Demand
Min B ≡ (Pxx+Pyy) s.t. ̅
U(x,y)=𝑈 (or =Uo)
Max U(x,y) s.t. Pxx+Pyy=𝐵̅ (or 𝐼 ̅ , 𝑚
̅)
̅
Example: Min Pxx+Pyy s.t. x.3y.7 =𝑈
Example: Max U=x y s.t. Pxx+Pyy =𝐵̅ e.g., 𝑩
.3 .7 ̅ =$100

Solve using calculus ̅ For example, x.3y.7 =10

or solve MRSxy= Px/Py, U(x,y)=𝑈
Solve using calculus, or Solve MRSxy= Px/Py , PxX+PyY=𝐵̅
𝜕𝑈
MRSxy=MUx/MUy , MUx= Plug Expenditure in for B in
𝜕𝑥
̅
Hicksian (Compensated) Demand How much x and y should I buy to get 𝑼
Marshallians, get Hicksians!
Marshallian Demands for x & y How much x and y the cheapest way?
should I buy seeing these prices with this budget to max U? ̅) , yc (Px,Py,𝑈
xc (Px,Py,𝑈 ̅) ̅))
(or x*=H(Px,Py,𝑈
x*( Px,Py,𝐵̅ ) , y*( Px,Py,𝐵̅) Plug Indirect in for U in .7 .3
Hicksians, get Marshallians!
̅ (3𝑃𝑦 ) , yc = 𝑈
Example: xc =𝑈 ̅ (7𝑃𝑥 )
Example: x*= .3𝐵̅/Px y*=.7𝐵̅/Py 7𝑃 𝑥 3𝑃 𝑦

Substitute x* and y* Roy’s Identity Substitute xc and yc Shephard’s Lemma

−𝜕𝑈 ∗ 𝜕𝑈 ∗ 𝜕𝐸
into the utility function / = x* similar for y*, use Py into the Budget equation = xc similar for yc, use Py
𝜕𝑃𝑥 𝜕𝐵 𝜕𝑃𝑥

Indirect Utility Function: Direct utility converts x and y into ̅ in the cheapest way
Expenditure Function How much does it cost to get 𝑼
Solve Indirect for B
happiness. Indirect uses prices and budget to do this, indirectly. given Px & Py?
(Invert)
̅) = Pxxc + Pyyc
E(Px,Py,𝑈
𝐵 .3 𝐵 .7
Utility*= V(Px, Py, 𝐵̅) Example: U = .5423*
( ) ( ) .7 .3 .7 .3
𝑃𝑥 𝑃𝑦
Solve Expenditure for U ̅ (3𝑃𝑦 ) + Py 𝑈
Example: Px 𝑈 ̅ (𝑝𝑦 ) (𝑝𝑥 )
̅ (7𝑃𝑥 ) = 10𝑈
7𝑃 𝑥 3𝑃 𝑦 7 3
(Invert)

Indirect Money Metric Utility Function: Take the Indirect Utility function and put Money Metric Utility Function: Plug the original utility function into the
bars on 𝑃̅𝑥 , 𝑃̅𝑦 , 𝐵̅. Substitute this fn. into the expenditure function for 𝑈
̅. This will
Expenditure function. This tells you “The mimimum $ needed to get the same
tell you how much $ you need to get the same utility you were getting at 𝑃̅𝑥 , 𝑃̅𝑦 , utility as I get from xo and yo. Example: MM=1.842𝑦𝑜.7 𝑥𝑜.3 𝑝𝑦.7 𝑝𝑥.3
𝑝𝑥 𝑝𝑦 𝐵 .3 .7 ̅
𝐵̅ under new prices Px & Py. Example: IMM= .3 .7
𝑝̅𝑥 𝑝̅𝑦

Legend: Green indicates various common symbols others might use for the same thing.
B, I, m: Budget, Income, money: If they are a free variable, or the outcome.
𝐵̅ or (𝐼 ,̅ 𝑚
̅ , 𝑜𝑟 𝐵𝑜 ):The bar or subscript, e.g. Bo (read “B nought”) means fixed level of income- the main constraint. Should think of as usually fixed.
U: Utility, happiness, satisfaction. 𝑈 ̅ or Uo : A fixed level of Utility that we want to achieve. U*: The optimal level of utility possible
x and y: Two goods we are consuming to produce Utility
x* and y* : Optimal levels of x and y that maximize utility; demand for x and y.
xc , yc : Hicksian demands for x and y; optimal levels of x and y that attain 𝑈 ̅ the cheapest way
Px and Py : Prices of the goods x and y.