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Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Consider a world with 2 goods (x and y), where Wilbur has well-defined preferences over bundles of those two goods, and those preferences can be represented by the utility function . Wilbur has income m and faces the parametric prices px and py. So Wilbur chooses the bundle that max s.t. .

Consider Wilburs Hicksian (conditional) demand functions for x and y.

where xh is the amount of x Wilbur would purchase to achieve utility level u given the prices px and py. The problem is min wrt to x and y s.t. The solution is that x and y that

min the cost of producing u utility given preference and the prices px and py

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

2 So, Hicksian demand functions are the solution to a cost minimum problem.

What would one get if one plugged ?

and

into the expenditure level

/ the minimum expenditures required to produce u given px and py.

That is, is the cost function to produce u given px and py.

We call it the expenditure function

It identifies minimum expenditure to produce u as a function of px and py.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

3 Properties of the expenditure function 1. 2. 3. Nondecreasing in p. That is, if then where . for . .

Homogenous of degree one in p. That is, Concave in p. That is, for . Continuous in p. That is,

4.

is continuous as a function of p for

The expenditure function has the same properties as the cost function.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

4 Since it has all the properties of a cost function (for producing u using the goods x and y) Shephards Lemma applies and

and

This gives us a very simple and straightforward way of deriving the Hicksian demand function. e.g. if

derive the Hicksian demand functions. By Shepards Lemma . And by analogy . Can you prove Hicksian demand functions do not slope up if if non 9 in p, and concave in p and twice differentiable? Yes, by Shepards Lemma (by concavity)

That is, the substitution effect is not positive, but not necessarily strictly negative.
Hicksian Demand Functions, Expenditure Functions & Shephards Lemma Edward R. Morey Feb 20, 2002

5 Duality between and

and That is, we can, in theory, derive the direct utility function from the expenditure function (and vice versa) How? The same way we derived the production function using Shepards Lemma. What would you get if you solved for u? from

Name this inverse function v, so . identifies maximum utility, u, as a function of prices, p, and the level of expenditures, E. If one sets the level of expenditures equal to income, m . identifies maximum utility as a function of income and prices. is called the indirect utility function.

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

6 can be shown to have the following properties: 1) 2) . 3) 4) is quasiconvex in p. That is, is continuous . is a convex set for all k. is nonincreasing in p. That is, if is homogenous of degree zero in , then . That is, . for

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002

7 Looking ahead one can show that

where is the demand function for good i. This result is know as Roys Identity. We will soon prove Roys Identity. Note that the demand function is sometimes referred to as the Marshallian demand function.

What is the difference between the Marshallian demand function

and the Hicksian demand function ?

Hicksian Demand Functions, Expenditure Functions & Shephards Lemma

Edward R. Morey Feb 20, 2002