UniversityofToronto,DepartmentofEconomics,ECO204,Summer2009.

AjazHussain
MidtermTest
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SCORES

Question
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2
3
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5
6
7

Out of
5
15
15
20
10
5
30
TOTAL SCORE (OUT OF 100)

Score

Thistestconsistsof7questions.Foryourconvenience,thereisaworksheetattheendofthis
test.Thereareatotalof16pagesincludingthecoverpageandworksheet.Keepyouranswers
brief.Goodluck!

Question1(5points)
SupposeaconsumerhastheutilityfunctionU=Q11/4Q23/4.Doestheutilityfunction:

U={Q11/4Q23/4}2

representthesamepreferencesastheutilityfunctionU=Q11/4Q23/4?Explainbriefly.

Question2(15points)
Youretryingtofigureoutaconsumerspreferencesandnoticethatregardlessofincomeor
prices,shealwaysspends10%ofherincomeongood1,20%ofherincomeongood2,40%of
herincomeongood3andtheremainderofherincomeongood4.
(a)(5points)Canyouguesswhatherutilityfunctionis?Explainbriefly.

(b)(5points)Whatisthedemandequationforgood3?Showallcalculations.

(c)(5points)Whataretheincomeandpriceelasticityofgood3?Show(any)calculations.

Question3(15points)
Aconsumerperceivesfourgoodgoodsascomplements.Assumepricesareuniformand,
alongwithincomeY,aregiven.
(a)(5points)Derivethedemandfunctionforgood2.Show(any)calculations.

(b)(5points)Whatistheelasticityofgood2withrespecttothetotalpriceofallgoods?

(c)(5points)SupposeP1=$10,P2=$100,P3=$40andP4=$50.Whatisimpactonthe
consumptionofgood2ifthepriceofgood2increasesby10%?Explainyouranswerandshow
anycalculations.

Question4(20points)
Acompanyuseslabor(L),capital(K)andmaterials(M)toproduceoutput(Q).Theproduction
functionis:Q=LKMwhere=,=and=.Suppose:PK=$10,PL=$20andPM=$20.

(a)(5points)Describethiscompanysreturns(notreturnstoscale).Showallcalculations.

(b)(10points)Nowsupposecapitalisfixedatk=100.Derivetheshortruncostfunctionand
showthatitexhibitsthereturnsinpart(a).Showallcalculations.

(c)(5points)Willthecompanyscostofproductionbeaffectedmorebyanincreaseinwages
orthepriceofmaterials?Showallcalculations.

Question5(10points)
Anindividuallivesfortwoperiods(T=1and2).Herrealincome(measuredinactualoutput,i.e.
notin$)whenshesyounginT=1isY1andherincome(measuredinactualoutput,i.e.notin
$)whenshesoldinT=2isY2.

LetT=1bethebaseperiodsothatP1=1andallowforthepossibilityofinflation(i.e.itmaybe
thatP1P2).Denotethenominalinterestratebyi.SupposethisindividualhasCobbDouglas
preferencesoverconsumptioninT=1andinT=2:U=C1C2

Thisindividualrecentlywonalottery(measuredinactualoutput).Shecanchoosetoreceive
theentireprizeeitherwhenshesyoungorwhenshesold.Thatis,shecanchoosetohave
Y1orY2.Whichoptionwouldshechoose?Showallcalculationsclearly.ItsOKtojustgive
notderivetherelevantintertemporalbudgetconstraint.Hint:Shellchoosewhichever
optionmakesherhappier.

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Question6(5points)
Acompanyuseslaborandcapitalascomplementstoproduceoutputwiththeproduction
functionq=min(L,K).UnderwhatconditionswillthiscompanyhaveaUshapedlongrunAC
(averagecost)curve?Showallcalculationsandexplainyouranswer.

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Question7(30points)
Acompanyuseslaborandcapitalascomplementstoproduceoutputwiththeproduction
functionq=min(L,K)+(noticethehere).
(a)(5points)Whatreturnstoscaledoesthecompanyhave?Showallcalculations.

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(b)(5points)Solvefortheoptimal(longrun)laborandcapitaldemands.Showallcalculations.

(c)(5points)Derivethelongruncostfunction.Showallcalculations.

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(d)(15points)PlottheACcurve(ACvs.output).Ifitseasierforyou,makeupnumbersfor
wages,priceofcapitaland.Hint:thereismorethanonecurve.

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WORKSHEET

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