Exercise Session 6, Nov 10th ; 2006

Mathematics for Economics and Finance

Prof: Norman Schürho¤
TAs: Zhihua (Cissy) Chen, Natalia Guseva

Exercise 1 Consider a competitive …rm that produces a single output y using

two inputs x1 and x2 . The …rm’s production technology is described by a Cobb-
Douglas function
y(x) = f (x1 ; x2 ) = x1 x2 ;
where + < 1, > 0 and > 0. Taking as given the output price p and the
input prices w1 and w2 , the …rm maximizes its pro…ts given by
(x) = py(x) wT x:
a) Does the production function exhibit decreasing, constant, or increasing
returns to scale? Show.
b) Write the …rst-order conditions and check whether su¢ cient conditions
for a maximum are satis…ed.
c) Solve for the …rm’s factor demands, giving the optimal input levels xi as
functions of input and output prices.
Exercise 2 De…ne the transformation f from A = (x1 ; x2 ) : x21 + x22 1
R2 into R2 by
f (x1 ; x2 ) = (x21 x22 ; x1 x2 ):
(a) Compute the determinant of the Jacobian of f and show that it is =
6 0
in the whole of A:(b) What does f do to the points (1; 1) and ( 1; 1). (c)
Comment on the results in (a) and (b).
Exercise 3 The function f (x1 ; x2 ; x3 ) = x21 + x22 + 3x23 x1 x2 + 2x1 x3 + x2 x3
de…ned on R3 has only one stationary point. Show that is a local minimum point.
Exercise 4 Assume the consumer’s utility function is Cobb-Douglas utility func-
tion: u(x1 ; x2 ) = kx1 x12 for some 2 (0; 1) and k > 0;and his budget con-
straint follows: p1 x1 + p2 x2 = w: Find the consumer’s optimal consumption
bundle.
Exercise 5 Suppose that in a two-commodity world, the consumer’s utility func-
1
tion takes the form u(x) = [ 1 x1 + 2 x2 ] :(CES)
(a) Show that when = 1, indi¤ erence curves become linear.
(b) Show that as ! 0; this utility function comes to represent the same
preferences as the (generalized) Cobb-Douglas utility function u(x) = x1 1 x2 2 :
(c) Show that as ! 1; indi¤ erence curves become “right angles”; that is,
this utility function has in the limit the indi¤ erence map of the Leontief utility
function u(x1 ; x2 ) = M in fx1 ; x2 g :
Exercise 6 Exercise4. Q5.