Microeconomics: Compulsory assignment

Rasmus Fisker Bang

March 6, 2015

Student number: 201405433 Group number: 2

06.03.2015
Problem 1
1.1
x1 (p, I) =

p2
p1 +p2

I
p1

x2 (p, I) =

p1
p1 +p2

I
p2

To check for homogenity, I multiply the functions by a constant t.

x1 (tp, I) =

tp2
tp1 +tp2

tI
tp1

= x1 (p, I)

x2 (tp, I) =

tp1
tp1 +tp2

tI
tp2

= x2 (p, I)

The functions are homogenous of degree zero.

Now I want to proof that all income is spent, therefore I use walras law.
p1 x1 + p2 x2 = E
2
p1 ( p1p+p

p2
p1 +p2

I
p1 )

+I

1
+ p2 ( p1p+p

p1
p1 +p2

I
p2 )

=E

=E

2
I( pp11 +p
+p2 ) = E

I=E
Thus all income is spent, consequently the consumer has rational preferences.
1.2
u
u
(tx)
(x)
x
x
1
= 1
u
u
(tx)
(x)
x2
x2
Therefore the functions are homothetic.x1
1.3
x1
p2 I
p2 I
=

< 0 Therefore the law of

p1
(p1 + p2 )p1 (p1 + p2 )2 p1
demand is satisfied.

Own-price effect:

I
p2 I
x1
> 0 Therefore the two
=

p2
(p1 + p2 )p1
(p1 + p2 )2 p1
goods are substitutes.

cross-price effect:

Income effect:

x1
I
=
> 0 Therefore the two goods are normal
I
(p1 + p2 )p1

goods.
I can use these results on x2 as well, because x1 and x2 are symmetric.
Problem 2
2.1
maxU (x, y) = x y 1 s.t. px x + py y = I
I write up the lagrangian and solve the problem.
L(x, y) = x y 1 (px x + py y I)
L
= x1 y 1 px = 0 =
x

x1 y 1
px

L
= (1 )x y py = 0 =
y

(1)x y
py

L
= px x py y + I = 0

x1 y 1
px

(1)x y
py

x1 y 1 py = (1 )x y px
py y =

y=

px (1 )x
x1 y 1

xpx ( 1)
py

px x + py y = I
px x + py (
x =

xpx ( 1)
)=I
py

I
(2 1)px

I
)px ( 1)
(2
1)px

y =
py
(

y =

( 1)I
(2 1)py

Now I insert the optimal values in the utility function.

U (x , y ) = (

I
( 1)I 1
) (
)
(2 1)px
(2 1)py

2.2
(

I
( 1)I 1
) (
)
=u

(2 1)px
(2 1)py

I now solve for I

(2 1)[
I = E(px , py , u
) =

( 1) px
] py u

py
1

2.3
?
Problem 3
3

1. False - The upper contour set is convex if the utility function is quasiconcave.
2. False - In the utility maximum the slope of the indifference curve and the
slope of the price vector are the same, therefore the gradient vector must
point in the exact same direction.
3. False - Because of inferior goods.
4. True - If the function is strictly quasi-concave then the upper contour set
is strictly convex, which means diminishing MRS.
5. True
6. True - With homothetic preferences the slope of the budget constraint
does not change, therfore the income expansion path will be linear.
7. True - Because the relative prices do not change.
8. True - Because when our income increases, we only consume more of one
good.
9. True - Because the numeraire is held constant.
10. False - When the price falls the consumer wants to consume more.
11. True
Problem 4
4.1
First I use shepards lemma.
xc1 =

E(p1 ,p2 ,u)

p1

xc = ( (1 )1 )p1
p1
u
1
2
xc = (1 (1 )1 )p1
p1
u
1
2
xc2 =

E(p1 ,p2 ,u)

p2

xc = ( (1 )1 )(1 )p11 p1
u
2

xc = ( (1 ) )p
1 p2 u

4.2
4

?
4.3
We say that:
E=I
( (1 )1 )p1
p1
u=I
1
2
u=

I
( (1 )1 )p1
p1
1
2

4.4
?
4.5
?