Expenditure minimization problem

In microeconomics, the expenditure minimization problem is another perspective on the utility maximization problem: "how much money do I need to be happy?". This question comes in two parts. Given a consumer's utility function, prices, and a utility target,

• how much money would the consumer need? This can be answered by the expenditure function. Or it can be answered by asking oneself 'how much do I really need to live well?". It is suprising how little expenditure a person needs to make in order to live a healthy, happy life.
• what could the consumer buy to meet this utility target while minimizing expenditure? This is answered by the Hicksian demand function.

Expenditure function

Formally, the expenditure function is defined as follows. Suppose the consumer has a utility function $u$ defined on $L$ commodities. Then the consumer's expenditure function gives the amount of money required to buy a package of commodities at given prices $p$ that give utility greater than $u^{*}$,

$e(p,u^{*})=\min _{x\in \geq {u^{*}}}p\cdot x$

where

$\geq {u^{*}}=\{x\in \mathbb {R} _{+}^{L}:u(x)\geq u^{*}\}$

is the set of all packages that give utility at least as good as $u^{*}$.

Hicksian demand correspondence

Secondly, the Hicksian demand function $h(p,u^{*})$ is defined as the cheapest package that gives the desired utility. It can be defined in terms of the expenditure function with the Marshallian demand function

$h(p,u^{*})=x(p,e(p,u^{*})).\,$

It is also possible that the Hicksian and Marshallian demand are not unique (i.e. there is more than one commodity bundle that satisfies the expenditure minimization problem), then the demand is a correspondence, and not a function. This does not happen, and the demands are functions, under the assumption of local nonsatiation.

See also

• Utility maximization problem

References

• Mas-Colell, Andreu; Whinston, Michael; & Green, Jerry (1995). Microeconomic Theory. Oxford: Oxford University Press. ISBN 0-19-507340-1

External links

• Anatomy of Cobb-Douglas Type Utility Functions in 3D