Assignment 4: Econ 2400C

Carleton University, Fall 2014 Due November 12th, 2014 by 4pm in Economics Drop
Box - Loeb C876 (across from the main oce). The assignment consists of 7 questions (which
are all to be completed). Provide a concise but clear explanation of your answers. A reasonable
attempt at a solution results in a passing grade. You are encouraged to work together, but you
must submit your own work.
1. Show that the Cobb-Douglas production function y = f(x
1
, x
2
) = Ax

1
x

2
, with 0 < , < 1
and + < 1 is strictly concave on x
1
, x
2
> 0.
2. Consider the function
C(x, y) =
x
2
100
10x +
y
3
300
9y + 20, 600,
dened for x 0 and y 0.
(a) Find the stationary point(s).
(b) Classify the stationary point(s) in part (a).
3. Consider the function
f(x, y, z) = x
3
+ 3xy + 3xz + y
3
+ 3yz + z
3
.
(a) Find the stationary point(s).
(b) Classify the stationary point(s) found in part (a).
4. Prove that if a function y = f(x) is concave, then it must be the case that f
ii
0 for all
i = 1, . . . , n.
5. (Total 30 points) For each of the following utility functions, derive the optimal choices
x(p, m) (referred to as Marshallian demand functions) using the standard budget constraint
p
1
x
1
+ p
2
x
2
= m:
(a) u(x
1
, x
2
) = 2x
1
+ x
2
(b) u(x
1
, x
2
) = x
1/2
1
x
1/3
2
(c) u(x
1
, x
2
) =
1
2
lnx
1
+
1
3
lnx
2
(d) What happens if we replace u by e
u
in part (c)? Compare this to part (b).
BONUS: Try to do the same for the following utility functions (you dont have to hand these
in). Hint: do not use calculus.
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(a) u(x
1
, x
2
) = max(x
1
, x
2
)
(b) u(x
1
, x
2
) = min(x
1
, x
2
)
6. For the problem solved in part (b) in the previous question:
(a) Check the second-order conditions for the maximum.
(b) Find an expression for the value function, i.e. the value of the utility function at the
optimum level of consumptionthis is generally referred to as indirect utility. Denote
this by V (p, m). Find V (p, m)/p
1
by dierentiating the expression you found and
verify your answer using the Envelope Theorem.
7. The theory of demand for money says that an individual will choose M (average money
holdings per period) and n (number of withdrawals per period) to minimize the cost of
holding money subject to the constraint that the individual is able to cover all her expenses
over the period. This can be formalized as the problem of choosing M and n to minimize
nPf + iM subject to: 2nM = Py
where P are prices, y is her planned consumption over the next period, f is a real xed cost
per withdrawal, and i is interest. (Total expenses for the period is Py.) All variables are
positive. This model may seem a bit strange, look it up if you are interested in the intuition,
but this is not necessary to solve the problem.
(a) Write down the Lagrangian for this problem.
(b) Write down the FOC and solve it for the optimal M

(the money demand).

(c) Show that the SOC for a (local) minimization problem is satised.
(d) Show that the interest elasticity of money demand, i.e. the (partial) elasticity of M

with respect to i, is equal to 1/2.

(e) Give an interpretation to the Lagrange Multiplier.
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