September 19, 2023

Consumer Optimization and Demand

András Olivér Németh

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 September 19, 2023

The Cobb–Douglas utility function

𝑝 𝑏
Marginal utilities: This means that 𝑥2∗ = 𝑝1 ∙ 𝑎 ∙ 𝑥1∗ .
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- 𝑀𝑈1 = 𝑎 ∙ 𝑥1𝑎−1 ∙ 𝑥2𝑏 > 0 and
- 𝑀𝑈2 = 𝑏 ∙ 𝑥1𝑎 ∙ 𝑥2𝑏−1 > 0 By substituting this back to the budget line, we
can calculate the optimal consumption bundle:
Marginal rate of substitution: 𝑎 𝑚 𝑏 𝑚
𝑥1∗ = 𝑎+𝑏 ∙ 𝑝 and 𝑥2∗ = 𝑎+𝑏 ∙ 𝑝 .
𝑎∙𝑥1𝑎−1 ∙𝑥2𝑏 𝑎∙𝑥 1 2
- 𝑀𝑅𝑆 = − 𝑎 𝑏−1 = − 𝑏∙𝑥2
𝑏∙𝑥1 ∙𝑥2 1
The consumer achieves the highest level of well-
being, if she divides her income among the goods
according to the powers in the utility function.
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 September 19, 2023

Consumer optimization
Perfect substitution
The marginal rate of substitution is constant.
- The consumer is willing to substitute the two
goods in a constant rate, independently from
the original consumption bundle.
The optimal consumption bundle depends on the
relation between the slope of the budget line and the
slope of the indifference curves:
𝑀𝑈 𝑝 𝑀𝑈1 𝑀𝑈2
- If 𝑀𝑈1 > 𝑝1 ( > ), the consumer buys
2 2 𝑝1 𝑝2
only 𝑥1 .
𝑀𝑈 𝑝 𝑀𝑈1 𝑀𝑈2
- If 𝑀𝑈1 < 𝑝1 ( 𝑝1
< 𝑝2
), the consumer buys
2 2
only 𝑥2 .
𝑀𝑈 𝑝 𝑀𝑈 𝑀𝑈
- If 𝑀𝑈1 = 𝑝1 ( 𝑝 1 = 𝑝 2), the consumer is
2 2 1 2
indifferent among the points of the budget line. 3
 September 19, 2023

Consumer optimization
Perfect complementarity
The consumer has a preferred ratio of the goods, if
he owns more of one good compared to this ratio, it
doesn’t provide any additional utility to the consumer.

Any consumption bundle different from this ratio

Optimal consumption bundle: the „corner point”

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Thank you
for your attention!