Download The Spatial Dixit

Tema 5 -EE
2. The Dixit-Stiglitz Model
1. Consumers Behavior:
We define sigma (σ) as:
σ
1
1
;ρ  1
1 ρ
σ
σ: elasticity of substitution between any 2 varieties
The consumer’s problem: maximize utility defined by the function U
subject to the budget constraint.
We solve it in 2 steps:
1. First, the consumption of varieties will be optimized:
1. The ideal consumption of each variety will be given by the
combination that ensures utility with the minimum cost (given
the relative prices of each variety).
2. Once the consumption of varieties in generic terms has been
optimized (for every M), the desired quantity of A and M will be
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chosen according to the relative prices of both goods.