Problem Set 3: Due on May 24
Advanced Microeconomics I (Spring, 1st, 2012)
1. Question 1 (4 points)
A real-valued function f (x) is called homothetic if f (x) = g(h(x)) where g : R → R is a strictly increasing function and h is a real-valued function which is homo- geneous of degree 1. Suppose that preferences can be represented by a homothetic utility function. Then, prove the following statements.
(a) The marginal rate of substitution between any two goods depends only on the ratio of the demands consumed. That is M RSij is identical whenever xi
xj takes the same value.
(b) The cross price derivatives of Marshallian demands are identical, i.e.,
∂xi(p, I)
∂pj =
∂xj(p, I)
∂pi . 2. Question 2 (6 points)
Assume that a consumer has preferences over the single good x and all other goods m represented by the utility function, u(x, m) = ln(x) + m. Let the price of x be p, the price of m be unity (= 1), and let income be ω.
(a) Derive the Marshallian demands for x and m.
(b) Use the Slutsky equation to decompose the effect of an own-price change on the demand for x into an income and substitution effect.
(c) Suppose that the price of x rises from p0 to p1(> p0). Calculate the (change of) consumer surplus, compensating variation, and equivalent variation. 3. Question 3 (6 points)
Consider the following (social welfare) maximization problem where ui is a strictly increasing and continuous function for all i ∈ I and (λ1,· · · , λI) ∈ RI+\ {0}.
max
x
∑I i=1
λiui(xi)
s.t.
∑I h=1
xkh ≤ ek for k = 1, ..., n.
(a) Under the above assumptions on ui for all i ∈ I, prove the equivalence between strong Pareto efficiency and weak Pareto efficiency.
(b) Show that any solution of the above maximization problem (you may denote x∗) must be Pareto efficient.
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(c) Find an example of Pareto efficient allocation that cannot be the solution of the maximization problem whichever (λ1,· · · , λI) ∈ RI+\ {0} will be chosen. 4. Question 4 (4 points)
Consider an exchange economy with two goods, x and y. Suppose that individuals have the following symmetric utility functions and symmetric initial endowments:
u(x, y) = x2+ y2 (ωx, ωy) = (1, 1)
(a) Assume there are only two individuals in this economy. Then, draw the Edgworth-box and show the contract curve. Find a competitive equilibrium if it exists. If there is no equilibrium, explain the reason.
(b) Now suppose there are n(> 2) individuals. Then, can we find a competitive equilibrium? (How) Does your answer depend on n?
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