p2
p1 + p2
!2
x2 (p, 1) =
p1
p1 + p2
!2
E) Where the prices of the two in puts are p1 and p2 , find the amount of
each factor that would be used to produce y units of output in the cheapest
possible way.
!2
p2
x1 (p, y) =
y
p1 + p2
p1
p1 + p2
x2 (p, y) =
!2
p1 p2
y
p1 + p2
p1 x1 (p, y) + p2 x2 (p, y) =
Question 2. A consumer has utility function
U (x1 , x2 ) = x1 1 + x2 1
defined over the set {(x1 , x2 )|x1 > 0, x2 > 0}.
A)Is this utility function strictly increasing in both goods at all points in its
domain? (Prove your answer.)
Yes, take derivatives and show that they are positive.
B) Find this consumers Marshallian demand functions for goods 1 and 2.
x1 (p, m) =
x2 (p, m) =
p1 +
m
p
p1 p2
p2 +
m
p
p1 p2
m
m
= p
p
p
p1 + p2 + p1 p2
( p1 + p2 )2
U (x1 , x2 ) = x1 1 + x2 1
A) Solve for the Marshallian demand functions for goods 1, 2, and 3, using a
two step procedure in which you first find the highest utility that a consumer
can achieve if he spends a total amount of money m on goods 1 and 2. (Hint:
use the answer from Question 2 to help you.) Now if the consumer has total
income M , find the best way to divide his expenditure, spending M m on
good 3 and m on goods 1 and 2.
If the consumer spends a total of m on goods 1 and 2 and M m on
good 3, her utility will be
xa3 V
1 a
(p1 , p2 , m)
m
p3
!a
m
p
p1 + p2 + p1 p2
!1 a
m
p3
aM
p3
(1 a)M
p
p1 + p1 p2
x2 (p, m) =
(1 a)M
p
p2 + p1 p2
a)1 a p3 a (p1 + p2 +
Question 4.
A ) State the weak axiom of revealed preference.
p1 p2 )a
Consider the following example. This is weakly convex but not strictly
convex. Let p0 = (1, 1) and also let p1 = (1, 1). Then the commodity bundle
(x01 , x02 ) = (2, 0) could be be chosen by a utility maximizing consumer with
utility function u(x1 , x2 ) = x1 + x2 and income 2. The bundle x1 = (1, 1)
could also be chosen by the same utility maximizing consumer with income
2. Now p0 x1 = p0 x0 = p1 x1 = p1 x0 = 2. Therefore we have p0 x1 p0 x0 and
also p1 x0 p1 x1 in violation of the weak axiom of revealed preference.
Question 5. An economy has two consumers and two goods. Consumer A
has the utility function
A
A
U (xA
1 , x2 ) = ln x1 + (1
) ln xA
2
ln xB
1 + (1
) ln xB
2
of his income on
!1A = !1A +
!2B
p
!1A .
Therefore E1 (
p) = 0 when
!2B
= (1
p
which is the case when
p =
)!
!2B
.
(1 )!1A
C) If the price of good 1 is the price you found in Part B, at what price will
excess demand for good 2 be zero?
The same price, by Walras Law.
D) Is there a competitive equilibrium in which the price of good 2 is 3? If
so, what must the price of good 1 be for there to be a competitive equilibrium
with the price of good 2 equal to 3?
Yes, multiplying all prices by a positive constant preserves competitive
equilibrium, so p2 = 3 and
p1 = 3
p=3
!2B
(1 )!1A
E) Find the quantities of good 1 and good 2 consumed by person A in competitive equilibrium. Find the quantities of good 1 and good 2 consumed by
person B in competitive equilibrium.
A
xA
1 = !1
xB
1 = (1
!1A
B
xA
2 = !2
xB
2 = (1
)!2B
cA
i
i
=
(10pA + 20)
pA
(10pA + 20)
pA
10).
(10pA + 20)
pA
10) = 0.
2
1
C) Solve for the competitive price for type A securities where dierent people
have dierent subjective probabilities for event A.
In equilibrium, we must have total excess demand for consumption contingent on event A equal to zero. Thus we need
1000
X
i=1
i
(10pA + 20) = 10, 000.
pA
(1)
Define
pi =
X
1 1000
i.
1000 i=1
2
1
D) Suppose that i 6= j , what is the ratio of person is competitive equilibrium consumption in event A to that of person j in event A?
ciA
i
=
.
j
cjA