Intermediate Microeconomics · free preview

Constrained Optimization: Substitution and Lagrange

Optimization in economics is optimization under a budget, and two equivalent methods solve it, eliminate a variable by substitution or introduce a Lagrange multiplier that prices the constraint itself.

1. The problem economics actually asks

The problem economics actually asks

2. Method one: substitution

Method one: substitution

3. Method two: Lagrange

Method two: Lagrange

4. The multiplier has a meaning

The multiplier has a meaning

5. What substitution eliminates

In the substitution method for maximizing U=x1x2U = x_1 x_2 subject to x1+x2=20x_1 + x_2 = 20, what exactly does the first move accomplish?

6. The Lagrangian's first-order conditions

For L=U(x1,x2)+λ(m−p1x1−p2x2)\mathcal{L} = U(x_1, x_2) + \lambda(m - p_1 x_1 - p_2 x_2), what do the conditions ∂U∂x1=λp1\frac{\partial U}{\partial x_1} = \lambda p_1 and ∂U∂x2=λp2\frac{\partial U}{\partial x_2} = \lambda p_2 state economically?

7. Tangency in numbers

At the optimum (10,10)(10, 10) of U=x1x2U = x_1 x_2 with p1=p2=1p_1 = p_2 = 1, what is the marginal rate of substitution MU1/MU2MU_1 / MU_2?

8. The multiplier's question

The Lagrange multiplier at an optimum equals 10. Which statement interprets it correctly?

9. The substitution optimum

Maximizing x1(20−x1)x_1 (20 - x_1) by the first-order condition, compute the optimal x1∗x_1^*, and write the number.

10. The multiplier at the optimum

For the problem maximize x1x2x_1 x_2 subject to x1+x2=20x_1 + x_2 = 20, compute the Lagrange multiplier λ\lambda at the optimum, and write the number.

11. The raised budget

If income rises from 20 to 21 with both prices at one, where does the optimum of x1 x2 move?

12. The equalized margin per dollar

The condition MU1 over p1 equals MU2 over p2 says which practical sentence?

13. Stripping lambda

Why divide one first-order condition by the other in the Lagrange setup?

14. Substitution versus Lagrange

When is the Lagrange method the more convenient route over substitution?

15. Utility after the raise

At the budget of 21 the optimum is (10.5, 10.5). Compute the new maximum utility and write the number with two decimals.

16. The shadow price of the budget

Lambda equals 10 at the optimum. Predict the utility gain from one more dollar and write that prediction.

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