The MRS and The Cobb-Douglas
The MRS and The Cobb-Douglas
U = xa y b
where a and b are two constants. In this case the marginal rate of substitution for the Cobb-Douglas utility
function is ³a´ ³y ´
M RS =
b x
regardless of the values of a and b.
U = xy
y
M RS =
x
Suppose Skippy’s budget information is as follows: B = 100, px = 1, py = 1. Her budget constraint is
B = px x + py y
100 = x + y
1
Step 1 Set MRS equal to price ratio
px
M RS =
py
y 1
=
x 1
y = x
100 = x + y
= x+x
= 2x
100 = x + y
1
100 = x + x
2
100 = 1.5x
100
x = = 66.7
1.5
y = 33.3
2
where the price ratio is px /py , the first rule of utility maximization yields
px
M RS =
py
ay px
=
bx py
b px
y = x
a py
Substituting into the budget constraint yields
µ ¶
b px
B = px x + py x
a py
b
B = px x + px x
¡ a+b ¢ a
B = a px x (see footnote for algebra)
³ ´B
x∗ = a
a+b p
x