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Problem Set 1 - SOLUTIONS ECH-32306 Advanced Microeconomics, Part 1, Fall 2016
Problem Set 1 - SOLUTIONS ECH-32306 Advanced Microeconomics, Part 1, Fall 2016
1. A consumer has a preference relation on R1 which can be represented by the utility function
u(x) = x2 + 4x + 4. Is this function quasi-concave? Briefly explain. Is there a concave utility
function representing the consumer's preferences? If so, display one; if not, why not?
Solution
Without loss of generality, consider any two points x1 , x2 R1 , such that x1 x2 . Because
du dx 0 for x1 R1 , we have u x1 u x2 , from which u x1 min u x1 , u x2 . Now,
form xt tx1 1 t x2 for t 0,1 . Because xt x1 and du dx 0 , it must be the case that
u xt u x1 min u x1 , u x2 , hence u(x) is a quasi-concave function.
1
Yes, there is such a concave utility function, for example: v x x , or v x x . 2
1
3. A consumer with convex, monotonic preferences consumes non-negative amounts of x1 and
x2.
1
a.) If u x1 , x2 x1 x
2
2 represents those preferences, what restrictions must there be on the
value of parameter ? Explain.
b.) Given those restrictions, calculate the Marshallian demand functions.
Solution
a.) Monotonicity requires
1
1 1
1
u x1 x1 1 x22 0 0 and u x2 x1 x2 2 0 . Because the
2 2
utility function is homogeneous of degree ½, it is strictly concave, hence also quasi-
concave and quasi-concave functions have convex superior sets (i.e., preferences are
convex). So no further restrictions on are required.
b.) x1
2 y
, x2
1 2 y .
p1 p2
a.) Write the consumer's problem as a constrained optimization problem and display the first
order conditions for this optimization problem.
b.) Show that if wealth increases then the demand for good 1 increases.
c.) What is the sign of the effect of a change in the price of good 1 on the consumer’s
demand for good 1? Show your work.
2
5. In a two-good case, show that if one good is inferior, the other must be normal.
3
Solution
p1 x1 p2 x2 y
x1 x
p1 p2 2 1
y y
x1 y p1 x1 x2 y p2 x2
1
y x1 y y x2 y
1s1 2 s2 1
where
x y px 2
i i , si i i ; si 1; i 1,2
y xi y i 1
Without loss of generality, assume x1 is the inferior good. Then, we must have 1 0 , which
means that 2 0 because 1>0. Thus, x2 must be a normal good.
Solution
One has to check all the properties of the Marshallian demand function, as well as the
negative semi-definiteness of the Slutsky matrix. The function above is not a Marshallian
demand function because the s11 px , p y ,I entry of the Slutsky matrix
2 I p x p y 2 p x 2
2
a.) Show that the form of individual i’s indirect utility function is V(p, yi) = V(p,1)yi, where
p = (p1,...,pN) is the price vector.
b.) Does there exist a positive representative consumer for this economy? Prove your
answer.
Solution
a.)
4
Vi p, yi max U x U x*
Vi p, yi U x* p, yi
Because U . is HoD 1, we have
U tx* p, yi tU x* p, yi
1
Now, take t
yi
1 1
U x* p, yi U x* p, yi
yi yi
1
Define z x* p, yi
yi
U z * p,1 1
yi
U x* p, yi
1
Vi p,1 Vi p, yi
yi
Vi p, yi yiVi p,1
8. There are two consumption goods x 0 and y 0 . An individual has homothetic preferences
with typical indifference curve I as illustrated below.
2
I
1
1 2 x
These goods can be purchased at prices p = (px, py).
a.) Provide a utility function, in which I is assigned utility level 1, that represents this
individual’s preferences.
5
b.) Find the expenditure function for utility 1, that is, e(p,1).
c.) Find the Hicksian demand for good x at utility 1, that is, hx(p,1).
d.) Is there a dual relationship between e(p,1) and hx(p,1) for this individual? Explain.
Solution
x y
a.) u x, y min x, y,
3
2 px p y for px p y
b.) e p,1 3 px for px p y
p 2 p for p p
x y x y
2 for px p y
c.) hx p,1 1, 2 for px p y
1 for p p
x y