maximise utility u=q1q2 when p1=1 p2=4 and ones budget = 120 estimate effect of an -1...

maximise utility u=q1q2 when p1=1 p2=4 and ones budget = 120 estimate effect of an -1 increase unit increase in the budget

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Expert Solution

The estimated effect of a unit increase in the budget on the utility is given by the value of Lagrangean Muliplier, lambda. Lambda is considered as a shadow price of the constraint. It tells us how the optimal value of the utility function changes with the value of the constraint used in the budget equations. In a way, we can say that lamba is the marginal utility of an extra $ of consumption expenditure and it denotes the marginal utility of income.

So, as calculated above there will be 15 unit change in the utility due to -1 increase in the budget.

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Rahul Sunny answered 5 months ago

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