You are on page 1of 6

Exercise Sheet 1. Consumer Theory 1. What are the assumptions made over preferences in standard consumer theory?

Do you think these assumptions are reasonable or might they not apply under some conditions? 2. What is a lexicographic ordering? Explain why such an ordering cannot be represented by a utility function in the absence of the assumption of continuity. 3. Assume that a consumer has a quasi-linear utility function u = v( x1 ) + x 2 where v' ( x1 ) > 0 and v' ' ( x1 ) < 0 . Derive the demand function for good 1 and show that it must have a negative slope. [Hint: write the demand function in inverse form i.e. p1 = f ( x1 ) ]. Derive the own-price, cross-price and income elasticities of demand for good 1. Is utility cardinal or ordinal in this case?
1 4. Assume the utility function is now u = x1 / 2 x 1 / 4 . Derive the demand function for 2 good 1 and show that it must have a negative slope. Derive the own-price, crossprice and income elasticities of demand for good 1. Is utility cardinal or ordinal in this case?

5. What is the Slutsky equation? Why is it important in the analysis of consumer demand? What is the Slutsky equation if utility is quasi-linear as in question 3? 6. What are the assumptions required to show that a consumer optimum exists, that it is a global optimum, and that it is unique? Are these assumptions reasonable in the consumer optimum case?

Exercise Sheet 2. Duality and Welfare 1. What is meant by the following: (a) the direct utility function, (b) the indirect utility function, (c) the expenditure function, and (d) Shephards lemma? What is the distinction between the Marshallian and the Hicks compensated demand function? 2. Show that Shephards lemma can be used to derive the compensated demand function.
1 3 3. Assume a consumer has a utility function u = x1 / 4 x 2 / 4 . Derive the Marshallian demand functions and the indirect utility function. Invert the indirect utility function to obtain the expenditure function and use Shephards lemma to obtain the Hicksian compensated demand curves. Show that the demand curves (Hicksian and Marshallian) slope downwards in this case.

4. Assume a consumer has a Stone-Geary utility function u = ( x1 c1 )1 / 2 ( x 2 c 2 )1 / 2 where c1 and c 2 are minimum subsistence levels for goods 1 and 2 respectively. Minimise expenditure to derive the Hicksian demand functions and the expenditure function. Show that Shephards lemma holds. 5. What are the CV, EV and CS measures of consumer welfare change? Under what circumstances will these measures be the same? 6. Evaluate the CV and EV measures in the case where a consumers utility function is u = x1 x 2 and M = 100 , p 2 = 1 and p1 falls from 2 to 1. Comment on the results you obtain.

Exercise Sheet 3. Revealed Preference/Allocation of Time 1. What are the assumptions of revealed preference theory? Explain how they differ from the assumptions in the indifference curve approach. 2. What is the integrability problem? Explain how it can be dealt in the revealed preference approach. 3. Define the Laspeyres and the Paasche indices of price changes. Why is it advantageous to use a Laspeyres price index in determining cost of living increases in pensions or other forms of income. Under what circumstances would a pensioner or income earner be unconcerned as to which index is used? 4. Describe briefly Beckers theory of the allocation of time. What types of issue does it help to explain? 5. An individual makes choices between two commodities: watching a Premier league football club, say Arsenal, with a high entrance fee and watching a local team, Islington United, with a lower entrance fee. How will he react if (a) he receives an increase in non-wage income, and (b) he receives an increase in his wage rate? What assumptions are you using in reaching your conclusions? 6. Suppose changes in the household production function mean that less time is required to complete household chores (e.g. cooking, washing-up, etc.). What effect will this have on the households demand for non-work activities?

Exercise Sheet 4. Production and Cost Theory 1. What is meant by (a) technical efficiency, and (b) output efficiency? Is it reasonable to assume that both types of efficiency exist in the theory of the firm? 2. Define and interpret the elasticity of substitution. Explain why it can be important in analysing firms and markets. 3. An entrepreneur employs L units of labour and K units of capital to produce a good, say football replica shirts. The firm has a Cobb Douglas production function Q = AL K 1 where A = 100 and = 1 / 2 . In the short run, the amount of capital is fixed at K = 10 units. Assume that the wage rate w = 2 , the cost of capital r = 1 and the output price p = 1 . How much labour should the firm hire? How much should it hire if (a) the wage falls to w = 7 / 4 , (b) the price rises to p = 5/ 4 ?

4. What is the distinction between homothetic and homogeneous production functions? Show that a homogeneous production function must be homothetic but the reverse need not be true. 5. Explain why a firm must be operating at a point of diminishing returns to its variable input in the short run in a competitive output market, and that it must be operating at a point of constant returns to scale in the long run. [Assume in both cases that input prices are fixed]. 6. Determine the returns to scale for each of the following production functions: (a) min (
z1 z 2 , ) b1 b2 b1 , b2 > 0

(b) y = az1 + bz 2
b (c) y = z1a z 2

a, b > 0
a, b > 0

Exercise Sheet 5. Partial and General Equilibrium 1. What is the difference between partial and general equilibrium analysis? Give examples in which it might be appropriate to use one or other type of approach. 2. Explain the distinction between the Marshallian and Walrasian process in moving to a new competitive equilibrium. Explain why they can give rise to different results under certain circumstances. What are the strengths and weaknesses of each approach? 3. An individual has a utility function u = x1 x 2 where x1 is leisure and x 2 is consumption of a good. Assume he has 16 hours available in a day and has a production possibility function x12 + x2 = 256 . Draw a diagram to illustrate this case. Show the equilibrium solution if (a) the individual chooses the optimal amount of labour (hours worked) and (b) the government restrict working to a maximum of 6 hours a day. Comment on your results.
4. What is meant by the core in an exchange economy. Explain why prices under recontracting go to Walrasian prices if there are sufficient individuals involved in exchange. 5. In an exchange economy individual A (Robinson Crusoe) has 100 units of good X 1 (coconuts) and 30 units of good X 2 (fish) while individual B (Man Friday) has 50 units of good X 1 and 20 units of good X 2 . Each has a utility function 1 u = x1 / 2 x 1 / 2 . Show that, initially, these individuals are not on the contract curve. 2 What is the marginal rate of substitution of each individual on the contract curve? Derive the Walrasian equilibrium in this case and comment on your results.

Exercise Sheet 6. Welfare Economics 1. Outline the conditions for a Pareto optimal allocation of resources in the case of two individuals, 1 and 2, two goods, X 1 and X 2 , and two inputs, Z1 and Z 2 . Assume initially that quantities of Z1 and Z 2 are fixed. What additional conditions are required if the amount of capital and labour can also be varied? 2. What are the first and second theorems of welfare economics? Explain why they are important in the application of public policy in a market economy. What problems arise in applying them in practice? 3. What is Arrows impossibility theorem? Does the theorem imply that it will never be possible to obtain a transitive social preference ordering? 4. What are the Paretian value judgements? Do you think they provide a sound basis for public policy analysis? 5. Explain why public goods are unlikely to be supplied in optimal quantities in a market economy. Is it desirable for the government to supply such goods, or might some other mechanism be used?

You might also like