√

Question 1 Let U (x, y) = x + y be the utility function for two goods, good x and good
y. Find the indirect utility function and use roy’s identity to find the ordinary demand.

Answer 1 First, do the utility maximization

√
max x + y s.t. px ∗ x + Py ∗ y − M
√
L = x + y − λ(px ∗ x + Py ∗ y − M )
∂L
= 1 − λ ∗ Px
∂x
∂L 1
= √ − λ ∗ Py
∂y 2 y
1
λ=
Px
1
λ= √
Py ∗ 2 y
P2
ŷ = x2
4Py
1 P2
x̂ = ∗ [M − x ]
Px 4Py
√ 1 Px 2
Px
Note that indirect utility function is V (Px , Py , M ) = x̂ + ŷ = Px
∗ [M − 4P y
] + 2P y
. Then
use the roy’s identity which is follows:
∂V
xd = − ∂P
∂V
x

∂M
∂V
∂Py
yd = − ∂V
∂M

∂V ∂V

Now, compute − ∂P
∂V
x
and − ∂Py
∂V .
∂M ∂M

∂V 1 P2
= 2 ∗ [M − x ]
∂Px Px 4Py
∂V Px
=
∂Py 4Py2
∂V 1
=
∂M Px
Verify the identity. Similarly do for the Cobb-Douglas utility function.
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Question 2 Let U (x, y) = x + y be the utility function for two goods, good x and good
y. Find the expenditure function.

1
Answer 2 For expenditure function the objective function is Px ∗x+Py ∗y and the constraint
√
is Ū = x + y. Then we do the expenditure minimization problem:

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max px ∗ x + Py ∗ y s.t. x + y = Ū
√
L = px ∗ x + Py ∗ y − λ(x + y − Ū )
∂L
= Px − λ
∂x
∂L λ
= Py − √
∂y 2 y
λ = Px
λ
λ= √
2 y
P2
ŷ = x2
4Py
Px
x̂ = Ū −
2Py
2
Px
Px
And the expenditure function is e(Px , Py , Ū ) = Px ∗ x̂ + Py ∗ ŷ = Px ∗ [Ū − 2P y
] + Py ∗ 4P 2 =
y
Px2
Px ∗ Ū − 4Py
.
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Question 3 Find out the Hicksian compensated demand for the U (x, y) = x + y using
the expenditure function via Shepherd’s Lemma. utility maximisation along the Hicksian
compensated budget line.

Answer 3 We have the expenditure function from above question. Shephard’s lemma is as
follows:
∂e
xh =
∂Px
∂e
yh =
∂Py

Where xh , y h are hicksian demand for good x, y respectively. Now compute the above:
∂e Px
xh = = Ū −
∂Px 2Py
∂e P2
yh = = x2
∂Py 4Py

Now, to find the hicksian compensated demand by using the utility maximization way,
we start with a price vector (Px , Py ) and suppose the price of good x changes to Px′ . Now

2
from question 1 we know that demand bundle of good x, y are as follows:

Px2
ŷ =
4Py2
1 P2
x̂ = ∗ [M − x ]
Px 4Py

Now for hicksian compensated demand we find out the utility of the demand bundle,
Px2 ′ 2 Px′
which is Ū = P1x ∗ [M − 4P y
Px
] + 2P y
= P1x ∗ [M h − (P4Pxy) ] + 2P y
. Then, we find the demand
′
bundle at price vector (Px , Py ) which is :

(Px′ )2
ŷ =
4Py2
1 h (Px′ )2
x̂ = ∗ [M − ]
Px′ 4Py
Px ′ ′ 2
Where M h is the compensated income, which is M h = Px′ ∗ [Ū − 2P y
] + (P4Pxy) . Substituting
′Px
that will give us x̂ = Ū − 2P y
. Note that this is same as if we compute the hicksian demand
′
at price vector (Px , Py ) in above.