OPMT 5701
Optimization with Constraints
The Lagrange Multiplier Method
Sometimes we need to to maximize (minimize) a function that is subject to some sort of
constraint. For example
Maximize
z = f (x, y)
subject to the constraint
x + y 100
For this kind of problem there is a technique, or trick, developed for this kind of problem
known as the Lagrange Multiplier method. This method involves adding an extra variable to
the problem called the lagrange multiplier, or .
We then set up the problem as follows:
1. Create a new equation form the original information
L = f (x, y) + (100 x y)
or
L = f (x, y) + [Zero]
2. Then follow the same steps as used in a regular maximization problem
L
x
L
y
= fx = 0
= fy = 0
= 100 x y = 0
3. In most cases the will drop out with substitution. Solving these 3 equations will give
you the constrained maximum solution
Example 1:
Suppose z = f (x, y) = xy. and the constraint is the one from above. The problem then
becomes
L = xy + (100 x y)
Now take partial derivatives, one for each unknown, including
L
x
L
y
=y=0
=x=0
= 100 x y = 0
Starting with the first two equations, we see that x = y and drops out. From the third
equation we can easily find that x = y = 50 and the constrained maximum value for z is
z = xy = 2500.
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Example 2:
Maximize
u = 4x2 + 3xy + 6y 2
subject to
x + y = 56
Set up the Lagrangian Equation:
L = 4x2 + 3xy + 6y 2 + (56 x y)
Take the first-order partials and set them to zero
Lx = 8x + 3y = 0
Ly = 3x + 12y = 0
L = 56 x y = 0
From the first two equations we get
8x + 3y = 3x + 12y
x = 1.8y
Substitute this result into the third equation
56 1.8y y = 0
y = 20
therefore
x = 36
= 348
Example 3: Cost minimization
A firm produces two goods, x and y. Due to a government quota, the firm must produce
subject to the constraint x + y = 42. The firms cost functions is
c(x, y) = 8x2 xy + 12y 2
The Lagrangian is
L = 8x2 xy + 12y 2 + (42 x y)
The first order conditions are
Lx = 16x y = 0
Ly = x + 24y = 0
L = 42 x y = 0
Solving these three equations simultaneously yields
x = 25
y = 17
2
= 383
(1)
Example of duality for the consumer choice problem
Example 4: Utility Maximization
Consider a consumer with the utility function U = xy, who faces a budget constraint of
B = Px x + Py y, where B, Px and Py are the budget and prices, which are given.
The choice problem is
Maximize
U = xy
(2)
Subject to
(3)
B = Px x + Py y
The Lagrangian for this problem is
Z = xy + (B Px x Py y)
(4)
The first order conditions are
Zx = y Px = 0
Zy = x Py = 0
Z = B Px x Py y = 0
(5)
Solving the first order conditions yield the following solutions
xM =
B
2Px
yM =
B
2Py
B
2Px Py
(6)
where xM and y M are the consumers Marshallian demand functions.
Example 5: Minimization Problem
Minimize
Px x + Py y
(7)
U0 = xy
(8)
Z = Px x + Py y + (U0 xy)
(9)
Subject to
The Lagrangian for the problem is
The first order conditions are
Zx = Px y = 0
Zy = Py x = 0
Z = U0 xy = 0
Solving the system of equations for x, y and
1
Py U0 2
h
x = Px
1
Px U0 2
h
y = Py
12
h = PUx P0 y
3
(10)
(11)
Application: Intertemporal Utility Maximization
Consider a simple two period model where a consumers utility is a function of consumption
in both periods. Let the consumers utility function be
U(c1 , c2 ) = ln c1 + ln c2
where c1 is consumption in period one and c2 is consumption in period two. The consumer
is also endowments of y1 in period one and y2 in period two.
Let r denote a market interest rate with the consumer can choose to borrow or lend
across the two periods. The consumers intertemporal budget constraint is
c1 +
c2
y2
= y1 +
1+r
1+r
Method One:Find MRS and Substitute
Dierentiate the Utility function
dU =
1
c1
dc1 +
c2
dc2 = 0
Rearrange to get
dc2
c2
=
dc1
c1
The MRS is the Absolute value of
dc2
dc1
:
MRS =
c2
c1
substitute into the budget constraint
y1 +
y2
c1 (1 + r)
= c1 +
= (1 + )c1
1+r
1+r
y2
y1 + 1+r
c1 =
(1 + )
Similarly, solving for c2 using the first order conditions
c2
c2
y2
=
+
1+r
(1 + r) 1 + r
1
(1 + r)y1 + y2 =
+ 1 c2
(1 + r)y1 + y2
c2 =
1
+1
y1 +
Method Two: Use the Lagrange Multiplier Method
The Lagrangian for this utility maximization problem is
y2
c2
L = ln c1 + ln c2 + y1 +
c1
1+r
1+r
The first order conditions are
y2
c2
L
= y1 + 1+r
c1 1+r
L
= c11 = 0
C1
L
= c2 1+r
=0
C1
=0
Combining the last two first order equations to eliminate gives us
1/c1
c2
=
= =1+r
/c2
c1
1+r
c2 = c1 (1 + r)
and
c1 =
c2
(1 + r)
sub into the Budget constraint
y1 +
y2
c1 (1 + r)
= c1 +
= (1 + )c1
1+r
1+r
y2
y1 + 1+r
c1 =
(1 + )
Similarly, solving for c2 using the first order conditions
y2
c2
c2
=
+
1+r
(1 + r) 1 + r
1
(1 + r)y1 + y2 =
+ 1 c2
(1 + r)y1 + y2
c2 =
1
+1
y1 +
Problems:
1. Skippy lives on an island where she produces two goods, x and y, according the the
production possibility frontier 200 = x2 + y 2 , and she consumes all the goods herself.
Her utility function is
u = x y3
FInd her utility maximizing x and y as well as the value of
2. A consumer has the following utility function: U(x, y) = x(y + 1), where x and y
are quantities of two consumption goods whose prices are px and py respectively. The
consumer also has a budget of B. Therefore the consumers maximization problem is
x(y + 1) + (B px x py y)
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(a) From the first order conditions find expressions for x and y . These are the consumers demand functions. What kind of good is y? In particular what happens
when py > B/2?
3. This problem could be recast as the following dual problem
Minimize px x + py y subject to U = x(y + 1)
Find the values of x and y that solve this minimization problem.
1
4. Skippy has the following utility function: u = x 2 y 2 and faces the budget constraint:
M = px x + py y.
(a) Suppose M = 120, Py = 1 and Px = 4. Find the optimal x and y
REVIEW:Partial Derivative Rules:
U
U
U
U
U
= xy
= xa y b
a
= xa y b = xyb
= ax + by
= ax1/2 + by 1/2
U/x = y
U/x = axa1 y b
U/x = axa1 y b
U/x = a
U/x = a 12 x1/2
U/y
U/y
U/y
U/y
U/y
Finding the MRS from Utility functions
=x
= bxa y b1
= bxa y b1
= b
= b 12 y 1/2
EXAMPLE: Find the total dierential for the following utility functions
1. U(x1 , x2 ) = ax1 + bx2 where (a, b > 0)
2. U(x1 , x2 ) = x21 + x32 + x1 x2
3. U(x1 , x2 ) = xa1 xb2 where (a, b > 0)
4. U(x1 , x2 ) = ln c1 + ln c2 where (, > 0)
Answers:
U
= U1 = a
1. x
1
and
U
x2
= U2 = b
dU = U1 dx1 + U2 dx2 = adx1 + bdx2 = 0
If we rearrange to get dx2 /dx1
U
dx2
U1
a
1
= x
=
=
U
dx1
U2
b
x2
The MRS is the Absolute value of
dx2
dx1
:
MRS =
a
b
U
U
= U1 = 2x1 + x2 x
= U2 = 3x22 + x1
2. x
1
2
and
dU = U1 dx1 + U2 dx2 = (2x1 + x2 )dx1 + (3x22 + x1 )dx2 = 0
Find dx2 /dx1
dx2
U1
(2x1 + x2 )
=
=
dx1
U2
(3x22 + x1 )
The MRS is the Absolute value of
dx2
dx1
MRS =
(2x1 + x2 )
(3x22 + x1 )
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U
U
b
= U1 = axa1
= U2 = bxa1 xb1
iii) x
1 x2
2
x2
1
and
a b1
b
dU = axa1
dx2 = 0
1 x2 dx1 + bx1 x2
Rearrange to get
b
dx2
U1
axa1
ax2
1 x2
=
= a b1 =
dx1
U2
bx1
bx1 x2
The MRS is the Absolute value of
dx2
dx1
:
MRS =
iv)
and
U
c1
= U1 =
1
c1
dc1 =
c1
dU =
Rearrange to get
U
x2
dc1
c1
ax2
bx1
dc1 +
= U2 =
c2
1
c2
dc2 =
dc2 = 0
c1
dc2
U1
c2
=
= =
dc1
U2
c1
c2
The MRS is the Absolute value of
MRS =
dc2
dc1
c2
= (1 + r)
c1
c2 = c1 (1 + r)
and
c1 =
c2
(1 + r)
c2
dc2