ECONOMICS 207

SPRING 2005
FINAL EXAMINATION

Problem 1 (30 points). Consider the following matrices.


J =


3
,
2

4
2

b =

 
8
4

a. Find the determinant of the matrix J.

The determinant of a 2 x 2 matrix is defined as, | J | = a11 a22 a12 a21 . Substituting the
values in, we get, |J| = (4)(2) (3)(2) = 2.
b. Find the inverse of the matrix J using the adjoint method.
The adjoint matrix of J is the n n matrix whose (i, j) entry is the (j, i) cofactor of J. So
by finding the cofactor of each element in J, we get the adjoint matrix:


2 3
2 4

Then to find the inverse of J by the adjoint matrix, take the adjoint matrix times
gets us,
J 1

1
adjoint matrix
|J |


1 2 3
=
2 2 4


3
1
2
=
1 2

c. Using the inverse from part b, solve the system of equations

Date: December 28, 2006.

1

1
|J| .

This

ECONOMICS 207 SPRING 2005 FINAL EXAMINATION


J

x1
x2

 
8
4
 
 
x1
8

= J 1
x2
4
  
  
3
8
x1
1
2

=
4
x2
1 2
   
x1
2

=
x2
0
=

[2,0] is the solution vector.

d. Using row reduction, find the inverse of the matrix J and the solution to the system of equations J x = b.

4
2

  
 
x1
8
=
x2
4

3
2

To find the inverse of the matrix and the solution vector, set up a matrix that has J on the
left, the identity matrix in the center, and the vector b on the right. Then row reduce to get
the solution.

4
2

3
2

1
0

0
1



8
1

4
0

3
4
1
2

1
4
1
2

0
1



2
1 0 1

0 1 1
0

3
2

2
0

The inverse of J is


1
1

3
2

And the solution vector is [2,0].

Problem 2 (30 points). Consider a competitive firm with the following production function where
y represents the level of output of the firm and x represents the level of the single variable input.
y = f (x) = 400x + 60x2 3x3
The firm faces an output price of p = 10 and an input price of w = 5440.
a. Write a function representing the profit of the firm as a function of the given output and
input prices and the input level.

ECONOMICS 207

SPRING 2005

FINAL EXAMINATION

To find profit, take the revenue of the firm and subtract the firms total cost.

= p y TC
= pf (x) wx
=

(10)(400x + 60x2 3x3 ) wx

= 4000x + 600x2 30x3 5440x

= 1440x + 600x2 30x3
b. What is the profit maximizing level of input for this firm? Verify that the input level you
choose is the profit maximizing point.
To find the profit maximizing level of input for the firm, take the derivative of the profit
function with respect to input x ,set it equal to zero, and then solve for x.
(x)
d(x)
dx

1440x + 600x2 30x3

1440 + 1200x 90x2 = 0

4
90(x )(x 12) = 0
3
4
x =
or 12
3

To determine which of these points is a maximum, take the second derivative of the profit
function which is 00 (x) = 1200 180x. At x = 34 , 00 ( 43 ) = 1200 180( 43 ) = 960 > 0,
so it is a minimum. At x = 12, 00 (12) = 10(120 18(12)) = 960 < 0, so x = 12 is a
maximum and the optimal input level.
To find the optimal profit, substitute x = 12 into the profit function.

= 1440x + 600x2 30x3

= 1440(12) + 600(12)2 30(12)3
= 17280

The profit at the optimal input level is 17,280.

c. What is the level of output of the firm at the profit maximizing input level?
To find the optimal level of output given x = 12, we substitutex = 12 into the output
function.
y

= f (x) = 400x + 60x2 3x3

f (12)

= 400(12) + 60(12)2 3(12)3

= 8256

8256 is the optimal output level for the firm.

d. What is the marginal product (MPx ) of the variable input at the profit maximizing input
level?

ECONOMICS 207 SPRING 2005 FINAL EXAMINATION

Method 1: The partial derivative of f (x) with respect to x is the marginal product of x.
So we obtain
0

f (x)

400 + 120x 9x2

= 400 + 120 12 9 122

= 544

f (12)

Method 2: The optimality conditions for the profit maximization problem can be interpreted as

And since

f (x)
x

f (x)
= p
w = 0
x
x
is equal to MPx we get,
f (x)
x

w
5440
=
p
10
M Px = 544
=

e. Verify that pMPx = w at the profit maximizing input level?

To verify that pMPx = w, we plug in the respective values.
pM Px = (10)(544) = 5440 = w.

Problem 3 (40 points). For the following problem, write an equation that represents profit as a
function of the two inputs x1 and x2 . Output price is represented by p, output by y, the price of
the first input by w1 and the price of the second input by w2 . The production function is given by
y = f(x1 ,x2 ). Then find critical values of x1 and x2 . Verify that profit is maximized at these critical
values.
2/3 1/5

f (x1 , x2 ) = x1 x2
p = 15
w1 = 5,
2

The optimal level of x2 is 32 and

(x1 , x2 )
=
x2 x2

w2 = 3
3
40 .

= pf (x1, x2 ) w1 x1 w2 x2
2

15x13 x25 5x1 3x2

First, we need to solve the cortical points for x1 and x2 . To do this, take the partial derivatives of
x1 and x2 , set them equal to zero, and solve for x1 and x2 .

=
x1

=
x2

10x13 x25 5 = 0
2

3x13 x25 3 = 0

(1)

ECONOMICS 207

SPRING 2005

FINAL EXAMINATION

Since we know x2 = 32, we plug x2 = 32 into the equation,

1
1

= 10x13 (32) 5 5 = 0
x1
1

20x13 = 5
1
1
x13 =
4
1 3
x1 =
= 43
4
x1 = 64
The critical points are x1 = 64 and x2 = 32.
We can verify that (x1 , x2 ) is a maximum if we set up a Hessian Matrix such as:
 2

 (x1 ,x2 ) 2 (x1 ,x2 ) 
 x2

x1 x2 
 2 1
 (x1 ,x2 ) 2 (x1 ,x2 ) 
 x2 x1

x22
If the determinant of the Hessian Matrix (discriminant) is greater than 0 and the (1,1) entry is negative, then f has a local maximum. The first entry in the Hessian Matrix is found by taking the
derivative of f with respect to x1 two times, the (1,2) entry is determined by taking the derivative
of f with respect to x2 and with respect to x1 . The (2,1) entry is found by taking the derivative of f
with respect to x2 and then with respect to x1 , and the (2,2) entry is found by taking the derivative
of f with the respect to x2 twice.
The Hessian Matrix of the profit equation is:
 2
 (x1 ,x2 )
 x2
 2 1
 (x1 ,x2 )
 x2 x1


 10x251
 4

 3x 3

1
2 (x1 ,x2 ) 


x1 x2 

=

2 (x1 ,x2 ) 

 12 4
x22
 3 5
 x1 x2


2
1
x13

4
x25
2

12x13
9
5x25

The Hessian Matrix of the profit equation at the critical input levels x1 = 64 and x2 = 32 is:
 5

1


 192 32 


 1
 = 1 > 0
3


1024
40
 32



Since the discriminant of the Hessian Matrix is greater than zero, there is a local maximum with
x1 = 64 and x2 = 32.
To find the profit at the input levels, substitute x1 = 64 and x2 = 32 into the profit equation.
2

15x13 x25 5x1 3x2

2

= 15(64) 3 (32) 5 5(64) 3(32)

= 64
The maximized profit for the firm is 64.

ECONOMICS 207 SPRING 2005 FINAL EXAMINATION

For your information, the bordered Hessian in the constrained optimization problem written as
L(x1 , x2 , ) = f (x1 , x2 ) g(x1 , x2 )
is given by
2 L(x1 , x2 , )

x1 x1

2
L(x1 , x2 , )
HB =

x2 x1

g(x1 , x2 )
x1

2 L(x1 , x2 , )
x1 x2
2
L(x1 , x2 , )
x2 x2
g(x1 , x2 )
x2

g(x1 , x2 )

x1

g(x1 , x2 )

x2

ECONOMICS 207

SPRING 2005

FINAL EXAMINATION

Problem 4 (50 points). Consider a firm with a production function given by

y = f (x1 , x2 ) = 80x1 + 40x2 2x21 + 3x1 x2 2x22
The firm faces prices and a cost constraint given by
w1 = 6
w2 = 3
c0 = 96
Find the maximum output the firm can produce given the cost constraint and the stated prices.
Verify that this output is a maximum.
First, we must find the equation of the budget constraint. The budget constraint can be written
as w1 x1 + w2 x2 = 96.
Budget Constraint

= w1 x1 + w2 x2 = c0
6x1 + 3x2 = 96
6x1 + 3x2 96 = 0

Then to maximize output with a cost of $96 given these prices we set up the following Lagrangian
L
L
x1
L
x2
L

80x1 + 40x2 2x21 + 3x1 x2 2x22 (6x1 + 3x2 96)

80 4x1 + 3x2 6 = 0

40 + 3x1 4x2 3 = 0

= 6x1 3x2 + 96 = 0

If we take the ratio of the first two first order conditions we obtain:
80 4x1 + 3x2
40 + 3x1 4x2

6
=2
3
80 4x1 + 3x2 = 2(40 + 3x1 4x2 )
10x1 = 11x2
x1 = 1.1x2
=

Now plug this value for x1 into the last first order condition to obtain.
6x1 3x2 + 96

0
6(1.1x2 ) 3x2 + 96 = 0
9.6x2 = 96
x2 = 10
x1 = 1.1x2 = 1.1 10 = 11

ECONOMICS 207 SPRING 2005 FINAL EXAMINATION

We can also find the maximum y by substituting in for x1 and x2 .

y
f (11, 10)

= f (x1 , x2 ) = 80x1 + 40x2 2x21 + 3x1 x2 2x22

= 80 11 + 40 10 2 112 + 3 11 10 2 102
= 880 + 400 242 + 330 200
= 1168

The Lagrangian multiplier can be obtained by solving the first equation that was obtained by
differentiating L with respect to x1 .
80 4x1 + 3x2 6

= 0
80 4 11 + 3 10 6 = 0
6 = 66
= 11

To check for a maximum or minimum we need to set up the bordered Hessian

2

L(x1 , x2 , ) 2 L(x1 , x2 , ) g(x1 , x2 )

x1 x1
x1 x2
x1

L(x1 , x2 , ) 2 L(x1 , x2 , ) g(x1 , x2 )

HB =

x2 x1
x2 x2
x2

g(x1 , x2 )

g(x1 , x2 )
0
x1
x2
We compute the various elements of the bordered Hessian as follows
L = 80x1 + 40x2 2x21 + 3x1 x2 2x22 (6x1 + 3x2 96)
L
= 80 4x1 + 3x2 6
x1
L
= 40 + 3x1 4x2 3
x2
2 L(x1 , x2 , )
2 L(x1 , x2 , )
= 4 ,
= 4
x1 x1
x2 x2
2 L(x1 , x2 , )
2 L(x1 , x2 , )
=
=3
x2 x1
x1 x2
g(x1 , x2 )
g(x1 , x2 )
= 6,
=3
x1
x2
The derivatives are all constants. The bordered Hessian is given by

4 3 6
HB = 3 4 3
6
3 0
The determinant of the bordered Hessian is






 4 3 
 3 3 
 3 4 
2
3
4






(1) (4) 
+ (1) 3 
+ (1) 6 
3 0 
6 0 
6 3 
= 4 (9) 3 (18) + 6 33
= 288 > 0

ECONOMICS 207

SPRING 2005

FINAL EXAMINATION

The condition for a maximum is that (1)2 |HB| > 0, so this point x1 = 11, x2 = 10 is a relative
maximum. 1168 is the maximum output level within the given budget constraint.
Problem 5 (50 points). Consider a consumer with a utility function given by
1/3 1/5

u = u(x1 , x2 ) = x1 x2
The consumer faces prices and a utility target given by
p1 = 32
p2 = 75
u0 = 10

Find the minimum cost way to obtain the given level of utility. Verify that this cost is a minimum.
Some of the optimal values are as follows
x2 = 32
2 L(x1 , x2 , )
1
,
=
x2 x1
5
|HB | =

g(x1 , x2 )
1
=
x2
16

1
375

First, we must find the equation of the constraint

1/3 1/5

x1 x2

U0 = 10
1/3 1/5

x1 x2

10 = 0

Then to minimize the cost with utility of 10 given these prices we set up the following Lagrangian
1/3 1/5

10)

1/3 1/5
(x1 x2

10)

L = P1 x1 + P2 x2 (x1 x2
L
L
x1
L
x2
L

=
=
=

32x1 + 75x2
1 2/3 1/5
32 x1 x2 = 0
3
1 1/3 4/5
=0
75 x1 x2
5
1/3 1/5

= x1 x2

+ 10 = 0

Since we have already been given the optimal value of x2 is 32, substituting in the last equation
of the first order conditions, we obtain:
1/3

x1 (32)1/5 + 10

0
1/3

x1 = 5
x1 = 125

10

ECONOMICS 207 SPRING 2005 FINAL EXAMINATION

Plug x1 = 125, x2 = 32 in the first equation of the first order conditions, we get
1 2/3 1/5
32 x1 x2
= 0
3
1
32 (125)2/3 (32)1/5 = 0
3
1
2 = 32 3

25
= 1200
We can also find the minimum cost by substituting in for x1 and x2 .
Cost = P1 x1 + P2 x2
= 32 125 + 75 32
= 6400
To verify that x1 = 125 and x2 = 32 are minimums, set up a bordered Hessian matrix of the
Lagrangian.
2

L(x1 , x2 , ) 2 L(x1 , x2 , ) g(x1 , x2 )

x1 x1
x1 x2
x1

2
L(x1 , x2 , ) L(x1 , x2 , ) g(x1 , x2 )
det

x2 x1
x2 x2
x2

g(x1 , x2 )

g(x1 , x2 )
0
x1
x2
We compute the various elements of the bordered Hessian as follows
L
L
x1
L
x2
2 L(x1 , x2 , )
x1 x1
2
L(x1 , x2 , )
x2 x1
g(x1 , x2 )
x1
The bordered Hessian is given by

1/3 1/5

32x1 + 75x2 (x1 x2 10)

1 2/3 1/5
= 32 x1 x2
3
1 1/3 4/5
= 75 x1 x2
5
2 L(x1 , x2 , )
64
15
,
=
=
375
x2 x2
8
2
L(x1 , x2 , )
1
=
=
x1 x2
5
g(x1 , x2 )
2
1
,
=
=
75
x2
16
=

HB

64
375
1
5
2
75

1
5
15
8
1
16

2
75
1
16

0
1
Det(HB) =
<0
375
The condition for a minimum is that (1)2 |HB| < 0, so this point x1 = 125, x2 = 32 is a relative
minimum. 6400 is the minimum cost to get the utility level of 10.