Review Question Set #4 : Answer Keys

1. Dene G(x, y ) = 2x2 + 6xy + y 2 18 then we have G(x, y ) = 0. Applying the implicit function theorem, we have y x = Gx 4x + 6y = Gy 2y + 6x = 8 5

(1,2)

(1,2)

2. Substitute f (Y ), g (Y ) for C, M and dene H (X, I, Y ) Y f (Y ) + g (Y ) I X = 0. Then Y HI 1 = = I HY 1 f (Y ) + g (Y ) When investment increases, output increases much if f (Y ) (sensitivity of consumption to output) is big, and g (Y ) (sensitivity of import to output) is small.

3. (a) f (x) = 2 (b) f (x) = 3x2 3 (c) f (x) = 1 1/x2 4. (a) f (x) = 3x2 + 64x 6, f (x) = 6x + 64. (b) x= 64

642 4 3 6 . 23 f is increasing when f 0. It happens when x is outside of two solutions here. (c) Inection point is where f = 0, In other words, where f changes signs. Then the curve becomes either convex from concave or concave from convex. 1

Inection point is x = 32/3. 5. (a) Revenue : p x. Cost : w x Prot () : p x wx.

1 px(1/2) w . Value of marginal product = input factor price (marginal (b) FOC : 2

cost of adding one unit of input).

1 (c) SOC : 4 px(3/2) < 0

(d) () : px2 wx. FOC : 2px w = 0. SOC : 2p > 0. The stationary point is not prot maximizing. Because production function has increasing return to scale, a rm can increase prot whenever level of production increases.

6. Since f is concave, we have f (x + (1 )y ) f (x) + (1 )f (y ) (*). By denition, g (x + (1 )y ) = af (x + (1 )y ) + b. g is concave if af (x + (1 )y ) + b af (x) + (1 )af (y ) + b Note this is just equivalent to (*) whenever a 0. 7. (a) Dene y =
T t=1

yt . Utility from constant consumption :

1 1 1 1 1 1 1 u( y ) + u( y ) + ... + u( y ) = u( y ) () T T T T T T T Here Jensens inequality is just the property of concave function (u(ax+(1a)y ) au(x)+(1a)u(y )). For any consumption stream c1 = 1 y , c2 = 2 y , ..., cT = T y , 1 1 1 1 1 u( y ) = u( 0 y + ... + T y ) u(0 y ) + ... + u(T y ) T T T T T 2

1 + 2 + ... + T = 1, we have from Jensens inequality

Thus lifetime utility is maximized when the consumption is constant for every period. Formally, Jensens inequality states that for a concave function , ai xi ) aj ai (xi ) . aj

( (b) We can set up a Lagrangian as

T

L:
t=1

(1 + r )t u(ct ) + [
t=1

(1 + r )t (yt ct )]

FOC : Lct : u (ct ) = for every t = 1, ..., T , Implying c1 = c2 = ... = cT =

T t t=1 (1 + r ) yt T t t=1 (1 + r )

8. h(x) = min{f (x), g (x)}, f and g are concave functions. Then we have f (x + (1 )y ) f (x) + (1 )f (y ) g (x + (1 )y ) g (x) + (1 )g (y ) h(x + (1 )y ) = min{f (x + (1 )y ), g (x + (1 )y )} min{f (x), g (x)} + (1 ) min{f (y ), g (y )} = h(x) + (1 )h(y )