Intermediate Microeconomics Quiz 4

4th TA session, 2021 spring

June 8, 2022

(Only for Intermediate Microeconomics. Please do not distribute.)

Name:
Student ID:
Scores:

Number 1 2 3 4
Answer False True A D

1 (1pt) True or False? True or False? A Pareto efficient allocation maximizes a social welfare
function, even if there are consumption externalities.
False

2 (1pt) True or False? If the 2 agents in an economy are of identical initial endowments and
positive prices, then the post-trade allocation in a competitive market will be fair.
True

3 (1pt) An election is conducted among 3 candidates x, y and z. A score of 1 is awarded to a

first choice, 2 to a second choice and 3 to a third choice. The candidate who gets the smallest
sum of scores wins. There are 29 voters. 10 voters rank the candidate x first, y second, z third; 6
voters rank the candidate x first, z second, y third; 8 rank the candidate z first, y second, x third;
5 voters rank the candidate y first, z second, x third.
A. Candidate X wins
B. Candidate Y wins
C. Candidate Z wins
D. Nobody wins

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4 (1pt) A mountain village owns a common pasture where villagers graze their goats. The
cost to a goat owner of owning and caring for a goat is 4 RMB. The pasture gets overgrazed if
too many goats share the pasture. The total revenue from all goats on the common pasture is
f (g) = 48g − 2g 2 , where g is the number of goats on the pasture. The town council notices that
total profit from the pasture is not maximized if villagers are allowed to pasture goats for free.
The council decides to allow a goat to use the common pasture only if its owner buys it a goat
license. To maximize total profit (of villagers and council), how much RMB per goat should the
council charge?
A. 20
B. 24
C. 26
D. 22
We find out the optimal level of goats first. The total profit function is

Π = 48g − 2g 2 − 4g,

from which we know the optimal level g ∗ = 11. So the price pL of license shall satisfy
f (g)
− 4 − pL = 0.
g
Plug g = 11 into above equation we know that pL = 22

5 (3pt) Smith and Jones are stranded on a desert island. Each has in his possession some
slices of ham (H) and cheese (C). Smith is a choosy eater and will eat ham and cheese only
in the fixed proportions of 2 slices of cheese to 1 slice of ham. His utility function is given by
US = min(H, C/2).
Jones is more flexible in his dietary tastes and has a utility function given by UJ = 4H + 3C.
Total endowments are 100 slices of ham and 200 slices of cheese.
(a) Suppose Smith initially had 40H and 80C. What would the equilibrium position be? Draw
allocation and relative price of this equilibrium in Edgeworth box diagram.
(b) Suppose Smith initially had 60H and 80C. What would the equilibrium position be? Draw
allocation and relative price of this equilibrium in Edgeworth box diagram.
(c) Suppose Smith (much the stronger of the two) decides not to play by the rules of the game.
Then what could the final equilibrium position be?

Answers

a. Suppose the Walrasian Equilibrium exist, it is composed of a series of sets (Hs , Cs ), (Hj , Cj ),
which are feasible solutions to consumers’ utility maximization problem, and price vector (ph , pc )
, which is positive and let markets clear.

Utility maximization problem (UMP):

For Smith.

max min(Hs , Cs /2)

{Hs ,Cs }

s.t.Hs ph + Cs pc = ehs ph + ecs pc

= 40ph + 80pc

Since Smith is a price taker in market, his consumption plan is

40ph + 80pc 40ph + 80pc
(Hs , Cs ) = ( , × 2)
ph + 2pc ph + 2pc
= (40, 80).

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 For Jones.

max 4Hj + 3Cj

{Hj ,Cj }

s.t.Hj ph + Cj pc = ehj ph + ecj pc

= 60ph + 120pc

Jones consumption plan in this competitive market will be

Case 1. pphc > 34 , i.e. C is relatively more expensive than H, Jones only consumes H.

60ph + 120pc
(Hj , Cj ) = ( , 0)
ph

Case 2. pphc = 34 , Jones is indifferent with choosing H or C, i.e. any (Hj , Cj ) satisfying 4Hj +3Cj =
600 is good for him.
Case 3. pphc < 34 . Jones prefers C to H at this time.

60ph + 120pc
(Hj , Cj ) = (0, )
pc

Market clear conditions.

H market.

Hs + Hj = ehs + ehj
= 100

C market.

Cs + Cj = ecs + ecj
= 200

Here are only two markets in this economy. Once one of them clear, so does the other. So we
only focus on H market in following analysis when both consumers consumption plans are definite.
Suppose pphc > 34 ,

Hs + Hj = 100,
120pc
100 + = 100,
ph
means pc = 0, against the definition of walrasian equilibrium.
Suppose pphc = 34 ,

Hs + Hj = 100
40 + Hj = 100,

require Hj = 60, plug this back into Jones consumption plan we get

(Hj , Cj ) = (60, 120)

pc
Suppose ph < 34 ,

Hs + Hj = 100
40 + 0 = 100,

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 Contradictory!
The market will never clear at this relative price.

All in all, equilibrium exists in this endowment,which is

(Hs , Cs ) = (40, 80),

(Hj , Cj ) = (60, 120),

with price vectors

(ph , pc ) = (4, 3) × k, k ∈ ℜ+
pc 3
You can also write it as ph = 4 and assert that ph and pc are larger than 0.

Sum up. Whenever you solve Walrasian Equilibrium, write down each optimization problem
and solve them one by one. By now, you can find that consumers’ consumption plans are function
of relative prices. Relative prices are solutions to market clear conditions. After finishing these
steps, test your solution via following criteria.
1. In this competitive market, consumer’s utility is maximized (or producer’s profit is maximized).
2. Allocation in equilibrium is feasible.
3. Price vectors are positive.

b. You can use similar approach to get solutions displayed below.

Equilibrium position is composed of allocations

(Hs , Cs ) = (48, 96),

(Hj , Cj ) = (52, 104),

with price vectors (ph , pc ) = (4, 3) × k, k ∈ ℜ+

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6 (3pt) Suppose that Robinson Crusoe, who is trapped on an isolated island, produces and
consumes fish (F ) and coconuts (C). Assume that, during a certain period, he has decided to
work 200 hours and is indifferent as to whether he spends this time fishing or gathering coconuts.
Robinson’s production for fish is given by
p
F = lF

and for coconuts by p

C= lC ,
where lF and lC are the number of hours spent fishing or gathering coconuts. Consequently,

lC + lF = 200.

Robinson Crusoe’s utility for fish and coconuts is given by

√
U = F ·C

(a) If Robinson cannot trade with the rest of the world, how will he choose to allocate his labor?
What will the optimal levels of F and C be? What will his utility be?
(b) Robinson feels lonely on island, so he√ decides to establish and manage 2 firms to kill time,
one producing
√ fish with technology F = lF and the other producing coconuts with technology
C = lC . That’s to say, he is the only owner and the only worker of the two firms. Suppose
markets are perfect competitive, please help him define general equilibrium and find out firms’
production plan, consumer’s consumption composition and relative prices in equilibrium. (Hint:
Only relative prices matters, you can set worker’s wage w = 1. Both two firms will offer same per
hour wage due to perfect competitive markets.)

Answers

a. √
max FC
F,C,lf ,lc

p
s.t.F = lf
p
C = lc
lc + lf = 200

(lf∗ , lc∗ , F ∗ , C ∗ , U ∗ ) = (100, 100, 10, 10, 10)

b. The general equilibrium in this economy is a series of sets composed by (F R , C R , lfR , lcR )
- solution to consumer’s utility maximization problem (CUM), (F f , lff ) and (C f , lcf ) - solutions
to firms’ profit maximization problems (FPM) and prices (pf , pc , w) ∗ k (pf > 0, pc > 0, k > 0)
which let market clear.
FPM of firm producing fish

max pf F f − lff w
F f ,lff

q
s.t.F f = lff

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Production plan is

pf
Ff =
2w
p2f
lff = ,
4w2
p2f
with profits 4w .

FPM for firm producing coconuts

max pc C f − lcf w
C f ,lcf

q
s.t.C = lcf
f

Production plan is

pc
Cf =
2w
p2
lcf = c2 ,
4w
p2c
with profits 4w .

CUM for Robinson

√
max F RC R
F R ,C R ,lfR ,lcR

s.t.pf F R + pc C R = (lfR + lC
R
)w + prof itsf romF + prof itf romC
lfR + lC
R
= 200

Consumption plan is
200w + prof itsf romF + prof itf romC
FR =
2pf
200w + prof itsf romF + prof itf romC
CR =
2pc
Simplify above expression by plugging firms’ profits into them.
p2 p2c
R 200w + 4wf + 4w
F =
2pf
p2 p2c
R 200w + 4wf + 4w
C =
2pc

Labor supply plan shall satisfy lfR + lC

R
= 200.

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 Market clear conditions

Fish market: F R = F f
Coconuts market: C R = F f
Labor market: lfR + lC
R
= lff + lcf

WLOG, use Fish and Coconuts markets to solve equilibrium.

p2 p2c
200w + 4wf + 4w pf
F ish : =
2pf 2w
p2 p2c
200w + 4wf + 4w pc
Coco : =
2pc 2w
Solve from above equations gives

pf
= 20
w
pc
= 20
w
Negetive relative prices are delted.
To sum up, plug w = 1

(F R , C R , lfR , lcR ) = (10, 10, 100, 100)

(F f , lff ) = (10, 100)
(C f , lcf ) = (10, 100)
(pf , pc , w) ∗ k = (20, 20, 1) ∗ k

The allocation is optimal as well as feasible with price vector larger than 0.

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Additional question in TA session
LJS (L) and HL (H) are stranded on a desert island and they consume good 1 and good 2.
Endowments for them are assumed to be
eL (eL L
1 , e2 ) = (1, 1)

eH (eH H
1 , e2 ) = (1, 0).

Their preferences are

uL (xL L L
1 , x2 ) = x2

U H (xH H H H
1 , x2 ) = x1 + x2 .

Is there any Walrasian Equilbrium in this economy?

Answers.
Suppose the Walrasian Equilibrium exist, it is composed of a series of sets (xL L H H
1 , x2 ), (x1 , x2 ),
which are feasible solutions to consumers’ utility maximization problem, and price vector (p1 , p2 )
, which is positive and let markets clear.

For L.
max xL
2
{xL L
1 ,x2 }

s.t.xL L
1 p1 + x2 p2 = 1 × p1 + 1 × p2
= p1 + p2
Obviously, L chooses
p1 + p2
(xL L
1 , x2 ) = (0, )
p2
to maximize his utility.

For H.
max xH H
1 + x2
{xH H
1 ,x2 }

s.t.xH H
1 p1 + x2 p2 = p1

When p1 > p2 ,
p1
(xh1 , xh2 ) = (0, ).
p2
When p1 = p2 ,
(xh1 , xh2 ) ∈ {xh1 , xh2 |xh1 + xh2 = 1, xh1 ≥ 0, xh2 ≥ 0}.
When p1 < p2 ,
(xh1 , xh2 ) = (1, 0).

Market clear conditions

Suppose p1 > p2 , for market of good 1,
xL H L H
1 + x1 = e1 + e1
0 + 0 = 2,

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Market cannot clear in this case, which is contradictory. Walrasian Equilibrium doesn’t exist when
p1 > p2 .
Suppose p1 = p2 , for market of good 1,

xL H L H
1 + x1 = e1 + e1

0 + xH
1 = 2,

for market of good 2,

xL H L H
2 + x2 = e2 + e2

1 + xH
2 = 1,

By now, we just assume market is clearing and plug L’s consumption plan into market clear
conditions. Note that xh1 + xh2 = 2 > 1 at this time, H is also happy to accept it. However, when
p1 = p2 , H will never afford this consumption plan, which is a contradiction.
Suppose p1 < p2 , for market of good 1,

xL H L H
1 + x1 = e1 + e1
0 + 1 = 2,

that is to say, market of good 1 cannot clear in this situation.

Walrasian Equilibrium doesn’t exist under settings of this problem.

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Draft leaves

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