Vaticrat
1) A consumer has m dollars to spend on good X and good Y which are sold in
competitive markets at prices PX and PY respectively. The consumer's preferences about
his consumption of goods X and Y are described by the utility function U(X,Y). Identify
the choice variables, the objective function, and the constraints, and characterize as fully
as possible the first-order conditions for an interior solution to the consumer's utility
maximization problem when:
a) Utility is a general function: U(X,Y)
Choice variables: X,Y
Objective function: U(X,Y)
Constraint: m − PX X − PY Y ≥ 0
[
L = U ( X , Y ) + λ m − PX X − PY Y ]
∂L
= MU X − PX = 0
∂X
∂L
= MU Y − PY = 0
∂Y
∂L
= m − PX X − PY Y = 0
∂λ
MU X P
The first two give = X and the third gives PX X + PY Y = m .
MU Y PY
a 1-a
b) U(X,Y) = X Y
Choice variables: X,Y
Objective function: U(X,Y) = XaY1-a
Constraint: m − PX X − PY Y ≥ 0
[
L = X a Y 1− a + λ m − PX X − PY Y ]
∂L
= aX a −1Y 1− a − λ PX = 0
∂X
∂L
= (1 − a ) X a Y − a − λ PY = 0
∂Y
∂L
= m − PX X − PY Y = 0
∂λ
aX a −1Y 1− a λ PX (1 − a ) PX
The first two give = which solves for Y = X.
(1 − a ) X a Y − a λ PY aPY
(1 − a ) PX m
Sub this into the third FOC: m − PX X − PY X = 0 which solves for X = a .
aPY PX
(1 − a ) PX (1 − a ) PX m m
Sub this result into Y = X to get Y = a = (1 − a ) .
aPY aPY PX PY
m m
Thus we have: X = a and Y = (1 − a ) .
PX PY
c) U(X,Y) = Xa + Ya
Choice variables: X,Y
Objective function: U(X,Y) = Xa + Ya
Constraint: m − PX X − PY Y ≥ 0
[
L = X a + Y a + λ m − PX X − PY Y ]
∂L
= aX a −1 − λ PX = 0
∂X
∂L
= aY − a − λ PY = 0
∂Y
∂L
= m − PX X − PY Y = 0
∂λ
aX a −1 λ PX
The first two give = solving for Y :
aY a −1 λ PY
X a −1 PX
=
Y a −1 PY
a −1
X PX
=
Y PY
1 1
X a −1 a −1 P a −1
= X
Y PY
1
X PX a −1
=
Y PY
1
P 1− a
Y= X X
PY
Sub this into the third FOC:
1
PX 1− a
m − PX X − PY X =0
PY
and solve for X :
−1 1
PX X + PY PY1− a PX1− a X = m
1 1
1−
PX X + PY 1− a
P 1− a
X X =m
−a 1
PX X + P Y
1− a
P 1− a
X X =m
−a
−a 1
P X
1− a
PX X + PY1− a −a PX1− a X = m
1− a
P X
−a
1 −a
PY1− a
PX X + −a PX1− a PX1− a X = m
PX1− a
−a
P 1− a 1 − a
PX X + Y PX1− a PX1− a X = m
PX
a
PX 1− a 1−1a 1−−aa
PX X + PX PX X = m
PY
a
PX 1− a 11−− aa
PX X + PX X = m
PY
a
PX 1− a
PX X + PX X = m
PY
a
P 1− a m
X+ X X =
PY PX
a
PX 1− a m
1+ X =
PY PX
a a
PY1− a + PX1− a m
a X =
PX
P
Y
1− a
a
PY1− a m
X = a a
PX
P 1− a
X + P Y
1− a
1 1 a
P 1− a P 1− a P 1− a
m
Sub this result into Y = X X to get Y = X Y
which can be
PY PY a a
PX
1− a
P
X + P Y
1− a
simplified:
a
1 −1
PY
1− a
m
Y= P 1− a
X PY
1− a
a a
PX
P 1− a
X + P Y
1− a
a
1 −1
P 1− a
PX−1m
Y
Y= P 1− a
X PY
1− a
a a
P 1− a
X + P Y
1− a
1
−1 a
PX1− a PX−1
Y= P Y
1− a
P Y
1− a
a a m
PX
1− a
+ P Y
1− a
1
−1
− 1+ a
P
1− a
X
Y = PY 1− a a a m
1− a
P
X + P
Y
1− a
1− (1− a )
−1 XP 1− a
Y= P Y a a m
X
1− a
P + P
Y
1− a
a
P1− a
X m
Y= a a
P
P X
1− a
+ P
Y
1− a Y
a a
PY1− a m PX1− a m
Thus we have X = a a and Y = a a .
PX PY
1− a
P
X + P Y
1− a 1− a
P
X + P Y
1− a
[
L = f ( X ) + Y + λ m − PX X − PY Y ]
∂L
= f ′ ( X ) − λ PX = 0
∂X
∂L
= 1 − λ PY = 0
∂Y
∂L
= m − PX X − PY Y = 0
∂λ
PX
The first two give: f ′ ( X ) = . Assuming f ( X ) is strictly concave (i.e. f ′′ ( X ) < 0 )
PY
then this uniquely defines X . This, along with m − PX X − PY Y = 0 defines Y .
1 3
e) U ( X , Y ) = X 2 Y 4 , m=50, PX=4, and PY=5
Choice variables: X,Y
1 3
Objective function: U ( X , Y ) = X 2 Y 4
Constraint: 50 − 4 X − 5Y ≥ 0
1 3
L = X Y + λ [ 50 − 4 X − 5Y ]
2 4
∂ L 1 −21 43
= X Y − λ4 = 0
∂X 2
∂ L 3 21 −41
= X Y − λ5 = 0
∂Y 4
∂L
= 50 − 4 X − 5Y = 0
∂λ
1 −21 43
X Y λ4
The first two give: 2 1 −1 = which solves for:
3 2 4 λ5
X Y
4
1
Y
2 = 4
3 5
X
4
2Y 4
=
3X 5
6
Y= X
5
Sub this into 50 − 4 X − 5Y = 0 to get:
6
50 − 4 X − 5 X = 0
5
6
X = 5. Sub this into Y = X to get Y = 6 .
5
1
f) U ( X , Y ) = X 2 + Y , m=100, PX=2, and PY=1
Choice variables: X,Y
1
Objective function: U ( X , Y ) = X 2 + Y
Constraint: 100 − 2 X − Y ≥ 0
1
L = X + Y + λ [100 − 2 X − Y ]
2
∂ L 1 −21
= X − λ2 = 0
∂X 2
∂L
= 1− λ = 0
∂Y
∂L
= 100 − 2 X − Y = 0
∂λ
1 −21
From the second one we have λ = 1 so the first one becomes X − 2 = 0 which solves
2
1 1 7
for X = . Sub this into the third one 100 − 2 − Y = 0 and solve for Y = 99 .
16 16 8
1 1
ℑ = rK + wL + λ y − K − L
2 2
∂ℑ 1 −1
= r−λ K2 = 0
∂K 2
∂ℑ 1 −21
= w− λ L = 0
∂L 2
∂ℑ 1 1
= y − K 2 − L2 = 0
∂λ
1 −21 −1
r λ K r K2
The first two give: = 2 −1 which solves for = −1
w 1 2 w
λ L L2
2
1
r L 2
=
w K
2
r
L= K.
w
1
r 2 1 2
Sub this into the third FOC: y − K − K 2
= 0 and solve for:
w
1
r 21
y = K2 + K
w
w + r 21
y= K
w
2
w 2
K= y .
w + r
2 2 2 2
r r w 2 r 2
Sub this into L = K to get L = y and simplify: L = y .
w w w + r w + r
2 2
w 2 2 1156
Using the values for y, r, and w: K = y = 17 2 = and
w + r 2 + 1 9
2 2
r 2 1 289
L= y = 17 2 = .
w + r 2 + 1 9
1 2
d) F ( K , L) = K 3 L3 , y=10, r=2, w=3
Choice variables: K,L
Objective function: rK+wL
1 2
Constraint: y − K L ≥ 0
3 3
1 2
ℑ = rK + wL + λ y − K 3 L3
∂ℑ 1 −2 2
= r − λ K 3 L3 = 0
∂K 3
∂ℑ 2 13 −31
= w− λ K L = 0
∂L 3
∂ℑ 1 2
= y − K 3 L3 = 0
∂λ
1 −32 23 −2 2
r λ K L r K 3 L3
The first two give: = 3 1 −1 which solves for: = 1 −1
w 2 w
λ K3L3 2K 3 L 3
3
r L
=
w 2K
r
L = 2 K.
w
2 2
1 2 1
r 3 r3
Sub this into y − K L = 0 to get y − K 2 K
3 3 3
= 0 and solve for y = 2 K
w w
2
w 3
K = y.
2r
2 1
r r w 3 2r 3
Sub this into L = 2 K to get L = 2 y which simplifies to L = y . At
w w 2r w
y=10, r=2, and w=3 we have:
2 2 1 1
w 3 3 3 2r 3 4 3
K= y= 10 ≈ 8.25 and L = y= 10 ≈ 1.10.
2r 4 w 3
3) A monopolist produces output y at a (minimized) cost of TC(y). It sells its output
subject to a demand constraint QD(P) where QD is the quantity demanded (which is a
function of the price the monopolist posts). Identify the choice variables, the objective
function, and the constraints, and characterize as fully as possible the first-order
conditions for an interior solution to the firm's profit maximization problem when:
a) Costs and demand are general functions: TC(y) and QD(P)
Choice variables: y, P.
Objective function: yP-TC(y)
Constraint: QD ( P) − y ≥ 0
[
L = yP − TC + λ QD ( P) − y ]
∂L
= P − MC( y ) − λ = 0
∂y
∂L ∂ QD ( P )
= y+ λ =0
∂P ∂P
∂L
= QD ( P ) − y = 0
∂λ
From the first one: λ = P − MC while from the third one y = QD ( P) .
∂ QD ( P )
[
Sub these into the second one: QD ( P) + P − MC(QD ( P) ) ]∂P
= 0 . This defines P.
Sub the resultant P into y = QD ( P) to get y.
b) TC(y)=by+c, QD(P)=d-eP
Choice variables: y, P.
Objective function: yP-by-c
Constraint: d − eP − y ≥ 0
L = yP − by − c + λ [d − eP − y ]
∂L
= P− b− λ = 0
∂y
∂L
= y − λe = 0
∂P
∂L
= d − eP − y = 0
∂λ
From the first one: λ = P − b and from the third one: y = d − eP .
Sub these into the third one: d − eP − ( P − b) e = 0 and solve for:
d − eP − Pe + be = 0
be + d
P= .
2e
be + d d − be
Sub this into y = d − eP to get y = d − e = .
2e 2
c) TC(y)=ay2+by+c, QD(P)=d-eP
Choice variables: y, P.
Objective function: yP-ay2-by-c
Constraint: d − eP − y ≥ 0
L = yP − ay 2 − by − c + λ [d − eP − y ]
∂L
= P − 2ay − b − λ = 0
∂y
∂L
= y − λe = 0
∂P
∂L
= d − eP − y = 0
∂λ
From the first one: λ = P − 2ay − b .
Sub this into the second one: y − ( P − 2ay − b)e = 0 .
From the third one: y = d − eP
Sub this into y − ( P − 2ay − b)e = 0 to get d − eP − ( P − 2a( d − eP) − b)e = 0 and solve
for: d − eP − ( P − 2ad + 2aeP − b) e = 0
d − eP − eP + 2ade − 2ae 2 P + be = 0
d + 2ade + be = 2e(1 + ae) P
d + 2ade + be
P=
2e(1 + ae)
Sub this into y = d − eP to get:
d + 2ade + be
y= d− .
2(1 + ae)
d) TC(y)=5y+10, QD(P)=100-2P
Choice variables: y, P.
Objective function: yP-by-c
Constraint: d − eP − y ≥ 0
L = yP − 5 y − 10 + λ [100 − 2 P − y ]
∂L
= P − 5− λ = 0
∂y
∂L
= y − λ2 = 0
∂P
∂L
= 100 − 2 P − y = 0
∂λ
From the first one λ = P − 5 .
Sub this into the second one: y − ( P − 5) 2 = 0
From the third one y = 100 − 2 P .
Sub this into y − ( P − 5) 2 = 0 to get 100 − 2 P − ( P − 5) 2 = 0 and solve for
100 − 2 P − 2 P + 10 = 0
55
P=
2
55
Sub this into y = 100 − 2 P = 100 − 2 = 45 .
2
1
e) TC(y)=y, QD ( P) = (100 − P 2 ) 2
Choice variables: y, P.
Objective function: yP-by-c
1
Constraint: (100 − P 2 ) 2 ≥ y
1
L = yP − y + λ (100 − P 2 ) 2 − y
∂L
= P − 1− λ = 0
∂y
∂L 1 −1
= y + λ (100 − P 2 ) 2 ( − 2 P) = 0
∂P 2
∂L 1
= (100 − P 2 ) 2 − y = 0
∂λ
1
From the first one: λ = P − 1 and from the third one: y = (100 − P 2 ) 2
Sub these into the second one:
1 −1
1
(100 − P ) + P − 1 2 (100 − P ) ( − 2 P) = 0
2 2
( ) 2 2
∑ λ [U ( X , G) − U ] + λ
n n
L = U 1 ( X 1 , G) + i i i i G PX ∑ ( E i − X i ) − PG G
i=2 i =1
∂L
= MU 1X − λ G PX = 0
∂X1
∂L
= λ i MU iX − λ G PX = 0
∂X i
∂L n
= MU 1G + ∑ λ i MU iG − λ G PG = 0
∂G i=2
λ G PX
From the second one: λ i = .
MU iX
MU iG
n
Sub this into the third one: MU + ∑ λ G PXG
1 − λ G PG = 0
i=2 MU iX
Divide through by λ G PX to get:
MU 1G n
MU iG PG
+∑ − =0
λ G PX i = 2 MU iX PX
Sub in the first FOC:
MU 1G n
MU iG PG
+∑ − = 0.
MU 1X i = 2 MU iX PX
Using the definition of MRSi :
n
P
MRS1 + ∑ MRSi − G = 0
i=2 PX
and rearranging:
n
P
∑i =1
MRSi = G (Which is the result we were looking for.)
PX
5) A pure public good G is produced using a private good as an input such that
G = f ( X ) where X is the total quantity of the private good used to produce the public
good. There are n consumers where consumer i's utility is represented by Ui(Xi,G). Xi is
consumer i's consumption of the private good X. Each consumer is endowed with Ei of
the private good. . Identify the choice variables, the objective function, and the
constraints for the planner's Pareto optimality problem. Using the first-order conditions
of an interior solution to this problem, show that the provision of the public good is
n
1
described by ∑ MRSi = MRT where MRT = .
i =1 f′
Choice variables: X1, X2, ..., Xn, G
Objective function: U1(X1,G)
n
Constraints: U i ( X i , G ) ≥ U i ∀ i ∈ {2,3,..., n} and f ∑ E i − X i ≥ G
i =1
n
[ ]
n
L = U 1 ( X 1 , G ) + ∑ λ i U i ( X i , G ) − U i + λ G f ∑ ( E i − X i ) − G
i=2 i =1
∂L
= MU 1X − λ G f ′ = 0
∂X1
∂L
= λ i MU iX − λ G f ′ = 0
∂X i
∂L n
∂G
= MU 1G + ∑ λ MU
i=2
i i
G
− λG = 0
λG f ′
From the second FOC: λ i =
MU iX
Sub this into the third one:
n
MU iG
MU 1G + ∑ λ G f ′ − λG = 0
i=2 MU iX
Dividing through by λ G f ′ :
MU 1G n
MU iG 1
+∑ X − =0
λ G f ′ i = 2 MU i f′
Sub in (from the first FOC) λ G f ′ = MU 1X :
MU 1G n
MU iG 1
X + ∑ X =
MU 1 i = 2 MU i f′
And using the definitions of MRSi and MRT :
n
MRS1 + ∑ MRS
i=2
i = MRT which becomes what we were looking for:
n
∑ MRS
i= 1
i = MRT
6) Repeat question 5 but instead of an endowed private good being used to produce the
public good have the public good be endowed (the entire economy starts with G ) and the
public good is used to produce a private good such that X=f( G -G) where X is the total
amount of the private good produced and G is the amount of the public good remaining
after production. (note that the definition of MRT will be different than in question 5).
Choice variables: X1, X2, ..., Xn, G
Objective function: U1(X1,G)
n
Constraints: U i ( X i , G ) ≥ U i ∀ i ∈ {2,3,..., n} and f (G − G ) ≥ ∑X i
i =1
∑ λ [U ( X , G) − U ] + λ
n n
L = U 1 ( X 1 , G) + i i i i G f (G − G ) − ∑ X i
i=2 i =1
∂L
= MU 1X − λ G = 0
∂X1
∂L
= λ i MU iX − λ G = 0
∂X i
∂L n
= MU 1 + ∑ λ i MU iG − λ G f ′ = 0
G
∂G i=2
λG
From the second FOC: λ i =
MU iX
Sub this into the third one:
n
MU iG
MU 1G + ∑ λ G − λG f ′ = 0
i=2 MU iX
Divide through by λ G :
MU 1G n
MU iG
+∑ X − f ′ = 0
λG i = 2 MU i
∑ MRS
i =1
i = MRT
7) There are n consumers each endowed with L units of time. Each consumer i's time is
split between production of the public good G and a private good X. Denote the amount
of time consumer i spends producing the private good LiX and the amount of time he
spends producing the public good LiG . The amount of the private good produced by the
n i
entire economy is X = f X ∑ L X and the amount of the public good produced by the
i =1
n i
entire economy is G = f G ∑ LG . Consumer i's utility is given by Ui(Xi,G) where Xi is
i =1
his consumption of the private good. Identify the choice variables, the objective function,
and the constraints for the planner's Pareto optimality problem. Using the first-order
conditions of an interior solution to this problem derive the appropriate Samuelson
condition.
n G n n
f G ∑ Li ≥ G , and nL ≥ ∑L X
+ ∑L G
i =1 i =1
i
i =1
i
n G n X
[ ]
n n n
L = U 1 ( X 1 , G ) + ∑ λ i U i ( X i , G ) − U i + λ G f G ∑ Li − G + λ X f X ∑ Li − ∑ X i + λ L nL − ∑L X
−
i =1 i =1
i
i=2 i =1 i =1
∂L
= MU 1X − λ X = 0
∂X1
∂L
= λ i MU iX − λ X = 0
∂X i
∂L
= λ G f G′ − λ L = 0
∂ LGi
∂L
= λ X f X′ − λ L = 0
∂ LiX
∂L n
= MU 1G + ∑ λ i MU iG − λ G = 0
∂G i=2
From the third and fourth FOCs:
λ G f G′ = λ L = λ X f X′
λ G f G′ = λ X f X′
f′
λG = λ X X
f G′
From the second FOC:
λX
λi =
MU iX
f X′
Sub this and λ G = λ X into the fifth FOC:
f G′
n
MU iG f X′
MU 1G + ∑
i=2
λX
MU i X − λX
f G′
=0
Divide through by λ X :
MU 1G n
MU iG f X′
+∑ X − =0
λX i = 2 MU i f G′
Sub in (from the first FOC) λ X = MU 1X :
MU 1G n
MU iG f X′
X + ∑ X − =0
MU 1 i = 2 MU i f G′
Sub in the definition of MRSi:
n
f′
MRS1 + ∑ MRSi − X = 0
i=2 f G′
f X′
Noting that, in this set-up, MRT = we get our result:
f G′
n
∑ MRS
i =1
i = MRT