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CHAPTER 2

Consumer Choice
2.1 Utility Functions and Marginal Utility Functions

We saw in Section 2.4 of the text that, for each consumer, we can attach a numerical score
to every consumption bundle; where bundle a receives a larger score than bundle b. If the
consumer under consideration prefers bundle a to bundle b. This numerical score is called
total utility. A utility function is a formula that shows the total utility associated with each
bundle. For example, suppose Ingrids utility function for x baked potatoes and y bowls of
pasta is U(x,y) = x1/2y1/2. If Ingrid consumes 9 baked potatoes and 16 bowls of pasta, then
her total utility is 12.
The marginal utility of a good given some bundle can be defined, in terms of calculus, as
the partial derivative of the utility function with respect to the amount of the given good
evaluated at that bundle. It reflects how the consumers total utility changes as the amount of
the good is increased by an infinitesimally small amount holding constant the amount
consumed of the other goods. Thus Ingrids marginal utility of baked potatoes evaluated a 9
baked potatoes and 16 bowls of pasta is )U(9,16)/)x = 12 91/2 161/2 = 2/3.
One can define a marginal utility schedule for a good as the partial derivative of the
utility function with respect to the amount of the good. If x denotes the amount of the good,
then this schedule is denoted MUx . Thus, for Ingrid, the marginal utility schedule for baked
potatoes is 12x1/2y1/2

2.2 Marginal Rate of Substitution

Recall that all bundles on the same indifference curve are liked equally well. This means that
each bundle on the same indifference curve has the same total utility. We can use the
concept of the total derivative to indicate how a function of more than one argumenthere,
total utilitychanges as all its arguments change (see the Appendix to this supplement for
details). Along an indifference curve, the total derivative is zero, because along an
indifference curve, total utility is constant. We can use this fact to calculate the slope of the
indifference curve. The slope, in turn, equals minus one times the marginal rate of
substitution.
Formally, if U = U(x,y), then the total change in utility from a small change in x and y is
dU = MUxdx + MUydy.
Along an indifference curve, dU = 0, so the above expression becomes
0 = MUxdx + MUydy.
Solving for dy/dxthe slope of the indifference curveyields
1

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dy
dx

MUx
MUy

Hence, since MRSyx = 1 slope of indifference curve = dy/dx, we have

MRSyx =

MUx
MUy

This is the same as Equation (2.5) found in the text (p. 57).
Consider Ingrid again, MUx = 12x1/2y1/2 and MUy = 12x1/2y1/2. Hence,
1
MRSyx =

2
1
2

x12y12
x12y

y
= .
x
12

2.3 Calculating the Consumers Equilibrium: An Example

Ingrids total utility for x baked potatoes and y bowls of pasta is x1/2y1/2. She is a price taker
with respect to baked potatoes and bowls of pasta. Let px and py denote the price per unit of
baked potatoes and bowls of pasta, respectively. Let I denote Ingrids income. In this section,
we will consider two equivalent ways to find Ingrids equilibrium.
One way is to use Equation (2.3) from the text (p. 47),
MRSyx =

px
py

along with our knowledge that the equilibrium bundle is on the budget constraint,
pxx + pyy = I.
As we will see, these are two equations in two unknowns (x and y). To solve these
equations, we begin with the following expression, which we derived in the previous section:
y

MRSyx =

for Ingrid. Hence, we have

px

y
= .
py x
This last equation (the tangency condition) and the budget constraint represent a system of
two equations in two unknowns (x and y). Solving the last equation for y yields.

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CHAPTER 2: CONSUMER CHOICE

y=

xpx
py

Plugging this expression for y into the budget constraint yields

pxx + pxx = I.
Solving for x yields
x=

I
2px

Plugging that back into the expression for y yields

y=

I
2py

These last two equations give us Ingrids equilibrium bundle (as a function of the prices
and her income).
A second way to proceed is to think of Ingrids choice problem as follows. Ingrid seeks to
find the x and y that maximize her total utility, x1/2y1/2, given what she can afford. We know
that this x and y pair will lie on her budget constraint. Solving her budget constraint for y,
y=

I
py

px
py

x,

we see that her equilibrium choice of y is a function of her equilibrium choice of x. Call
this function y(x). For future reference, note that dy/dx = px/pythe slope of the budget
constraint is minus one times the ratio of the prices. We can, thus, write Ingrids total utility
of her equilibrium bundle as
U(x) = x12[y(x)]12 .
Now, Ingrids equilibrium choice of x maximizes the above expression; hence, a necessary
condition satisfied by Ingrids equilibrium choice of x is1
1
1
dU dx = MUx + MUy dy dx = x12[y(x)]12 + x12[y(x)]12 dx dy = 0.
2
2
(Note our use of the chain rule in calculating the derivative of [y(x)]1/2 with respect to x.)
This equation can be rewritten as
1 px
y(x) x = 0.
2
2 py

Substituting for y(x), we have

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1 I
2 py

px
py

1 px
x x = 0.
2 py

Solving for x yields the same expression we found above for the equilibrium value of x,
I/px. Plugging this expression for x into y(x) yields the same expression for the
equilibrium value of y, 12 I/py, that we found above.
12

2.4 The Lagrange Method

We saw in the text that an individuals equilibrium bundle lies on his budget constraint. It
follows, then, that if we give this individual a little bit more money, _Ir, his utility at his
new equilibrium bundle, U1, must be grater than his utility his original equilibrium bundle,
U0. This individual can afford more of each good, so, by the assumption of nonsatiation, his
utility is greater. Define MUI as the marginal utility of incomethe amount by which total
utility changes in equilibrium per unit change in income:
MUI =

U1 U0
I

Since more money is better, MUI is positive.

Now, consider the general problem of a price-taking individual who consumes n different
goods, in quantities x1,,xn, and who seeks to maximize his utility, U(x1,,xn), subject to his
budget constraint, p1x1 + + pnxn I. Suppose, at his equilibrium bundle, he is
contemplating increasing his consumption of good 1 by _x1. Since he is on his budget
constraint at his equilibrium bundle, increasing his consumption of good 1 by _x1 means he
has p1 _x1 less to spend on the other goods. This is as if his income had been reduced
by p1 _x1, which means the cost in terms of utility is approximately MUI p1 _x1the
marginal utility of income times the reduction in income. On the other hand, there is a
benefit of increasing his consumption of good 1 equal to MU1 _x1, where MU1 is the
marginal utility of good 1.
At the individuals equilibrium bundle, the benefit must equal the cost. To see this,
suppose the benefit exceeded the cost. Then, the utility gained by increasing his consumption
of good 1 would be greater than the utility lost by decreasing his consumption of the other
goods. This, in turn, means there is an affordable bundle that this individual likes more than
his equilibrium bundlewhich is a contradiction. Similarly, if the benefit were less than the
cost, then the utility lost by decreasing his consumption of good I would be less than the
utility gained by using the freed-up money to buy more of the other goods. This, in turn,
means there is an affordable bundle that this individual likes more than his equilibrium
bundlewhich is also a contradiction. Mathematically, we have the requirement that
MU1 x1 = MUI p1 x1 ,
or, canceling the _x1 terms,

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MU1 = MUI p1 .
The term on the left-hand side can be seen as the marginal benefit from an increase in
good 1. The right-hand side is the marginal cost in terms of forgone utility from the
consumption of other goods (which is equal to the marginal utility of income times the
additional income spent on good 1). This equation is, therefore, the familiar condition for
optimal behaviour: Marginal benefit equals marginal cost (see, e.g., Section 1.2 of the text).
Of course, there is nothing special about good 1, so this expression must be true of all goods
at the equilibrium bundle; that is, we have the following n equations:
MU1 = MUI p1 ,
MU2 = MUI p2 ,
through
MUn = MUI pn .
These equations provide another way to characterize the equilibrium bundle.
The usefulness of this characterization might, at first, seem limited, since typically we do
not know MUI. That is, the above system of equations has n + 1 unknowns (x1, x2, , xn,
and MUI), but only n equations. Fortunately, however, there is another equation that we can
use, namely, the budget constraint:
p1x1 + . . . + pnxn = I.
So we have n + 1 equations, which we can solve for the n + 1 unknowns: the amounts
in the equilibrium bundle, x1, x2, , xn, and MUI.
For example, recall Ingrid from Section 2.3. For her, n = 2, because she consumes only
baked potatoes and bowls of pasta. So the above procedure yields the following three
equations:
1
2
1
2

x12y12 = MUx = MUI px ,

x12y12 = MUy = MUI py,

and
pxx + pyy = I.
Solving these equations for x, y, and MUI yields

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x=
y=

I
2px
I
2py

,
,

and
MUI =

1
2

p x py .

What we have just done is use a powerful mathematical technique known as the Lagrange
Method to solve the consumers problem of maximizing his utility subject to his budget
constraint. A more formal approach to this method is the following.
Step 1: Write the Lagrangean:
L = U(x1, . . . , xn) + (I p1x1 p2x2 . . . pnxn) .
That is, write the function to be maximized (here, utility) plus l times the constraint (here,
the budget constraint). As we will see, the variable lthe Greek letter lambdaplays the
same role that the variable MUI played above. Indeed, it will prove to be the marginal utility
of income.
Step 2: Differentiate with respect to x1, , xn, and l. Set the derivatives equal to 0:
L x1 = MU1 p1 = 0,
L x2 = MU2 p2 = 0,
through
L xn = MUn pn = 0,
and
L = I p1x1 p2x2 . . . pnxn = 0.
Note these equations can be re-expressed as

(2.4.1)

MU1 = p1,
MU2 = p2,
through
MUn = pn ,
and
p1x1 + p2x2 + . . . + pnxn = I.
Step 3: Solve these n + 1 equations for x1, , xn, and l.

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Note we get the same equations as beforethe only difference is that, here, we have the
Lagrange multiplier l and before we used MUI. However, as we did not know prior to
solving the equations what the marginal utility of income was, it cannot matter whether we
denote it as MUI or l.
Another way to see that these methods are really the same is to recall that, in equilibrium,
MUi
pi

MUj
pj

This is just a restatement of Equation (2.7) from the text (p. 57): Total utility is maximized
when the marginal utility of the last euro spent on each good is the same. Another way to
say this is that, at the equilibrium bundle, the increase in utility is the same no matter how
an additional euro is spent. In particular, we could spend it all on the first good. If we spend
an additional euro on good 1, we purchase 1/p1 more units of good 1, so the increase in
utility is MU1/p1. As we have just argued, however, this increase in utility is equal to the
marginal utility of incomeit does not matter how we spend that euro; that is, MU1/p1
equals the marginal utility of income. But, from Equation (2.4.1), MU1/p1 = l; thus, l really
is the marginal utility of income.

2.5 Exercises
2.5.1 Consider Anne. Like Ingrid, she consumes only baked potatoes and bowls of pasta. Her
utility from x baked potatoes and y bowls of pasta is equal to Ingrid utility squared, times 5,
plus 10; that is, her utility is
5 (x12y12)2 + 10.
Calculate the marginal utility functions of baked potatoes and bowls of pasta for Anne.
Calculate her marginal rate of substitution. How does it compare with Ingrids? How does
Annes indifference map compare to Ingrids?
2.5.2 Consider Anne again. Calculate Annes equilibrium consumption bundle. How does
it compare with Ingrids? Given the answer you found in Exercise 2.5.1, why should you not
be surprised by this answer? To get Annes utility function from Ingrids, we took a monotonic
transformation of Ingrids utility function, which means we constructed a composite-function
of Ingrids utility function and the function 5z2 + 10, where this new function is increasing.
Given these two problems, do you think two people have the same preferences if one
persons utility function is a monotonic transformation of the others? Relate your answer to
the distinction between ordinal and cardinal utility functions discussed in the text.
2.5.3 Consider Jolene, a price taker who consumes only baked potatoes and bowls of
pasta. Her utility function for x baked potatoes and y bowls of pasta is U(x,y) = x1/2 + y1/2.
The price of a baked potatoes is 4 and the price of a bowls of pasta is 2. Jolenes income
is 12. What is Jolenes equilibrium bundle of baked potatoes and bowls of pasta?
1

We leave it to the reader to verify that this is, indeed, a maximum and not a minimum.

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