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to accompany
The Structure of Economics
A Mathematical Analysis
Third Edition
Eugene Silberberg
University ofWashington
Wing Suen
University of Hang Kong
glrwin
D McGrawHill
Boston ßnrr Ridge, IL Dnbnqne, lA Madison, WI New York San Francisco St. Lonis
ßangkok Bogobi Caracas Lisbon London Madrid
Mexico City Milan New Delhi Seonl Singapore Sydney Taipei Toronto
The third edition of The Structure of Economics contains two brand new chapters. Chapter 15,
Contracis and Incentives, and Chapter 16, Markets with Imperfect Information, cover the exciting
recent developments in information economics. Wing Suen ofthe University ofHong Kong wrote
these chapters. We discarded the old Chapter 19 on stability of equilibrium in order to accommodate
this new material. Also discarded is most ofthe old Chapter 2, the calculus review, which we feel is
no Ionger important. Wehave maintained, however, the discussion ofTaylor's series, and some
topics that are not typically covered in elementary calculus courses, such as continuous compounding.
The traditional chapters of the text contain many emendations and clarifications, which we hope will
prove useful. We discarded the very general primaldual analysis bf statics presented as
Sec. 7.5 in the second edition, these results being of little practical use, in favor of greater analysis of
the more useful models where the parameters enter eilher the objective function or the constraint. We
have striven to keep the informal tone of the text in both the old and new chapters, and to focus on
deriving interestiflg and useful results, usmg the most elementary math that is required to do the job.
There is a tendency to treat comparative statics in a very terse manner, as though the whole subject
could be summarized by the solution to the matrix equation (H)(&!oa) = (fxa). We, however, see
comparative statics as the core methodology of economic science. As long as economists are not able
to measure tastes and other important functions which determine behavior, the only scientific (i.e.,
refutable) propositions we can derive will be Statements about how decision variables change when
parameters change, under the assumption of stability of those underlying functions. Thus the third
edition to this text remains fiercely devoted to the goal of deriving refutable propositions from
maximization hypotheses, and understanding the mathematical structures !hat yield these results.
CHAPTER 1
2. Assertions are those postulates which we believe to be universally true, such
as "more is preferred to less,t' diminishing MRS, etc. Assumptions, on the other hand,
are the test conditions of a given expedment; they are true only at a given moment,
e.g., the price of gasoline rose 20 cents a gallon at a certain time, etc.
4. This question is answered in the introductory paragraph. Of course, economists would
Iove to be able to predict total quantities. This will be impossible as long as some
variables are not measured.
2
11. We will once again derive dx' J dt < 0. This can be seen by setting R( x) = 0 in Example
1. Thus this theory yields the same refutable propositions as those in Examples 1
through 3.
13. The side of the can uses 1r Dh; the "waste," made up of .the· eight·corner pieces when a
circle is cut from two end squares, is k(2D
2
 J?J') = lcD
2
(2 :: kD
2
a, where
a = 2  and where 0 ::; k :5 1 the ability to recycle this material. The
objective function is thus
minimize
subject to
rrhD + 2D
2
 kD
2
a
rrD
2
h=l.
4
Using the constraint to eliminate h,
Therefore
minimize + D
2
(2 ;_ ka)
"D
41r
 rrD• +2D(2 ka) = 0 or
 rrh + 2D(2 ka) = 0.
h 42ka 4k(4rr)
v= " = "
When k = 0 (no recycling), jj = t; when k = 1 (no waste), jj = 1.
CHAPTER4
Section 4.2
3. For 0 < a,ß< 1,a+ß< 1,
J
YLL = <>(<> l)L"2 KP < 0
YKK = ß(ß l)L"J(P2 < 0
YLLYKK YLK = aß(l a ß)L2a2K2P2 > 0.
lf <> + ß = 1, the function is weakly concave.
4. YLL = a/L
2
< 0; YKK = ß/K
2
< 0·, 0
YLK = UKL = ; YLLYkK = aß/L
2
K
2
> 0.
Section 4.5
5.
"t = M Rt  M C  ty = 0
1r2=MR2MC=O
where M R; = T R;'. Differentiating with respect to t,
(a)
( b)
8yj 8y2
"117ft+ "127ft = 1
where the "'i 's are given as in Problem 6, Section 4.2. This problern has the same
structure as the profit maximization problern with respect to a change in factor prices.
We find, similarly,
The denominator is positive here, but 1r
12
= C"(y) = MG' 0. If marginal cost is
rising, then 8yif8t > 0.
(c) This follows the profitmaximizing firm example exactly.
3
4
Additional Comment:
It is even the ease that {}y• f8t = 8yjf8t + 8y2f8t does not have a determinate sign:
where D = 1<111<22 .  ~
2
> 0. Hence, only if the marginal revenue curve is downward sloping
in market 2 (a condition not implied by profit maximization) will total output sold by this
monopalist decrease in rcsponse to a tax increase. This result is known as the Edgeworth
taxation paradox.
6. Consider ditchdiggers and shovels. If the wage of ditchdiggers fall, holding the number
of shovels fixed will tend to reduce the firm's demand for ditchdiggers.
7. The model is now
maximize. = TR
1
+ TR
2
 C(y) ty
1
 ty
2
producing the firstorder relations,
.,=MRtMCt=O
.
2
=MR2MCt=O.
Since the parameter t enters 6oth firstorder relations, it will not be possible to sign
either 8yif8t or 8y2f8t. Letting D = 1<111<22 .  ~
2
,
(a) {}y•fat= (.11 +1<2z2.,2)/D<O, usingequation (48).
(b) If y
2
is held fixed, then this essentially becomes the onevariable monopalist of
Chapter 1; hence, ( 8yif8t)y, < 0.
8. Unless the revenue and cost functions can be measured, these two models are obser
vationally equivalent. The parameter t enters both models identically; oyj I 8t < 0 is
implied in both models and no other results are forthcoming.
9. The objective function is
     ~                                 
The first and secondorder conditions are
.. , = pft  w, = 0,
", .. pf" < 0
u u '
1r2 = pfa (1 + t)w2 = 0
D = p{!u/22 1[2) > 0.
(c) Differentiating the firstorder identities with respect to w
2
and t, ~ = w
1
7f =
8='
W2f.?.:'·
10. The objective function is
The model is essentially the sru:ne as the text problem; note, however, that the factor
demands are not homogeneaus of degree 1 in factor priees. There are no comparative
statics relations available for output price, since p is endogenous, being embedded in
11. This is an examination problem. It follows the earlier monopolistic discrimination
models. Note, however, in part (e), output price is endogenous. There is an implied
profitmaximizing output price. It makes no sense to ask about any other, nonimplied
price.
12. The fundamental identity is
Differentiating with respect to p and then W2,
[)y'  [)y' [)y' 8:t2
+
[)p  op o : t ~ op
[)y'  [)y' 8:t2
aw2 = a.,g aw2 ·
Using the second equation to eliminate oy' I a.,g from the first, and remembering that
oy' j8w
2
== 8:t2f8p.
[) • [) ' ( ~ ) 2
.J!_ := .J!_  _P_
ap  ilp ( ~ ) ·
Since 8:t2jow2 < 0, oy' fop > oy' f8p.
5
6
CHAPTER5
Text
2. Expanding by the first column: lAI = auAu. Since Aa is also the determinant of an
uppertriangular matrix, the result follows by induction.
APPENDIX
2. Multiply (AB)
1
AB =I by s
1
A
1
on the right.
4. Taking the transpese of AA
1
= I, (A
1
)' A' =I'= I. However, (A')
1
A' =I by
definition. Since inverses are unique, (Al)' = (A')
1
•
5. Apply matrix multiplication.
8. This follows because AA' = I implies that A' A = I (taking the transpese of both sides).
CHAPTER 6
1. and 2. These problems are straightforward generalizations of the text material. In each
case, if c>; enters only the ;<h firstorder relation, but not a constraint, then ßxi jßa; =
 L;.; times the ratio of some borderpreserving principal minor of H to the whole
Hessian determinant, H. These two determinants must have opposite sign, and thus
the result follows.
5. The equivalence of 4( c) and 4( d) is shown in Chapter 10 in the text.
6. The righthand matrix for"' is (1,0,0)'; for ß it is (0,A,x.)'. Thus, ßzjjßa =
H
11
f H > 0. Since ß enters two firstorder equations, no refutable propositions are
possible:
ßzj = A H21 _ x
2
Hat
ßß H H.
(b) Note that ßz';./ßa = Ht./H = H.tfH, ßA• jßa = Hta/H = H.tfH.
The result follows by substitution. When Chapter 7 has been covered, do this problern
again, using the duality results derived there.
8.
(b) Follows from second partials, AC;; = AC/;;/f. Note that 8(AC' f;)f8x; =
;AC'/;; f;8AC' f8x; =AC'/;; sii)ce 8AC' f8x; = 0.
(c) 8x,f8w, = (/22 + x,ff(h2f, !12!2))/AC(f"h2 ff
2
) ~ 0;8x,j8w, =
(/21 + x,ff(!Hh f2,J,))/AC(!ld22 ff
2
) ~ 0; reverse .the ones and twos to
get ax,j8w2, 8x2/8w2.
(d) From firstorder conditions, f; = w;/AC' = wd' /(w,xi+w2xi), multiply through
by x; and sum the two equations. This is not Euler's Theorem. This result, an
identify in w, and w2 (not x, and x
2
) holds only lft the point of miilimum AC,
not for all x,, x2.
CHAPTER 7
l(a) and (b). Fora, this follows the text exactly. Note that if x
1
and x 2 are held fixed, k
cannot be varied without violating the constraint.
(c) From the geometry in (a), rPa(a) = fa, and rPaa !aa > 0. However,
rPa(a) E /a(xi(o:), xi(a),o:).
Differentiating both sides with respect to a,
from which the result fo!lows.
( d) The primaldual problern is
subject to g(x
1
,x2) = k
7
_ i  ~                 
8
producing the Lagrangian
The firstorder conditions are
c, = "  )..g, = 0
c2 = 12 )..u2 = o
Ca= Ja <Pa= 0
c, =  < ~ > · +).. = 0
C>. = k g(z
1
,z2) = 0.
The third and fourth equations are the envelope theorem for <> and k. The secondorder
matrix ts
c"
c12 J.a
0 g,
c •• C2a ha
0
g·
H= f1a faa faa <l>aa <Pak 0
0 0 </>ka <Pu
1
g, ga 0 1 0
The borderpreserving principal minor formed by eliminating the first two rows and
columns,
faa </>aa <Pak ·0
H11.22 = </>u 1 = Uaa <l>aa) > 0
1 0
yields the only implied curvature property for </>, <l>aa > !aa·
(e) From <Pak= <l>ka, we have * = I!J:. Using d(1) and d(3),
from whieh the result follows by the implied differentiation.
(f) Of eourse, 8>.' f8k does not have an implied sign, unless f is eoneave and g is convex
in"'' and "'2·
(g) lf /(:z:,, :z:2, 01) = h(:z:,, :z:2) + OI:Z:l, !aa E 0, thus from (a) or (d), tf>aa 0 > 0.
2. This problern is a special case of problern 1, for the parameter 01. The reciprocity
condition in ( c) follows from
using the results of part b.
3. This problern is worked out in Cha.pter 8. It is a. useful exercise for students to do on
their own, however. Campare with the tr11ditiona.l methodology of Cha.pter 6.
4. LongRun
ShortRun:
s.t. w,:z:, + w2:z:2 = k
(a)
1t'• = 7r' = L
81r' 81r' 8L 81r' 81r'
===
aw, aw, aw, aw, aw,
= "'' >.:z:, = :z:,(l + >.).
9
10
In longrun, .\ = 0 from firstorder eonditions. Therefore, = xi. In shortrun,
,\ = l?h.  I = ill  I. Therefore,
Wt · W2
ehr'
 = xj(! + .\')
llw1
• IJ2L llxi
>>+
llw( llw( . llw, llw1
>
[ll(xf(l + .\'))] >
0
llw
1
_ [ll(xl(l + .\'))] = xj ( /).\')
. llw, llw1
_(I+.\') (llxf)
llw
1
"' + < 0
This doesn't imply < 0 sinee 0.
(b)
••' I
;:.::J.. From the enve ope theorem,
8w, ·
Therefore, the elasticities cannot be compared.
(c) However, if it is assumed that < 0, since = '1rkw
1
== '1t':U
1
k = W, therefore,
• h '
8
"'
8
"' ("'') •·· ••' ' h L Rd d'
ow, < 0; t ere.ore, < "' ..... < 0, or < t.e., t e  eman 1s
more elastic.
5. The first<>rder conditions are
Multiplying through by xt and summing,
Integration yields
CHAPTER 8
I: /;x; a r</> a A' I: g;k; a A'rk
84>
</> =
8
k k, Thus
84> 8k
r=T·
log </> = log k +log a, or
</> = ak.
1. The technology available to the firm is just one constraint facing the firm; it says nothing
about how a firm uses that technology. In order to be welldefined, i.e., to be useful
in deriving testable implications, cost functions must consider additional behavioral
assumptions and constraints, such as wealth ma.ximization. With differing behavioral
postulates, different costs will be associated with a given output Ievel.
2. Empirical reasons suggest that the .costminimization model should yield an interior so
lution, which in turn implies that the isoquants be postulated tobe convex to the origin.
Our observations refute the implications derived from the assumption of concaveto
the<>rigin isoquants. Such concave isoquants imply the firms will hire only one input.
This behavior is not observed. It is for this reason only that convex (to the origin)
isoquants are postulated.
11
12
5.
(a)
1r• = max{maxfpy w,x,  w
2
x
2
+ >.(f(x
1
, x2) y)]}
y .Z:t ,::2
= max{py+ max[w,x
1
 w
2
x
2
+ >.(f(x
1
,x
2
) y)]}
y :l:l ,.t:.
(b) The inner minimum is precisely the cost minimization prob lern; the outer maximum
specifies that this occurs at the ;>rofit maximizing Ievel of output.
(c) The first order conditions of the Lagrangian are:
L,, = w, + >.f
1
= 0
The matrix of the second derivatives of L is
0 0 0 1
o Vu >.!12 !t
(L;;) =
1 ,, !2 0
Its determinant, H, must be negative and its secondorder borderpreserving principle
minors, H;;, must be positive. Expanding H by the first column and then by the
remairring first row yields H = >.
2
(/u/22 !(
2
) < 0. The comparative statics are
found using (L;;) and Cramer's Rule. In particular, the reciprocity condition falls out
directly:
The supply slope follows from the signs given by the second order conditions,
ßy• = _ H
11
__ ( +) >
0
ßp H () '
These results also follow immediately from the theorems of Chapter 7.
6. Salve the first order conditions of the Lagrangian
From the first two conditions
or
Substitute this into the constraint,
then
13
14
And x; can be found directly, by summetry. C' is found by substituting xi, x; into
= kt yll/( a, +a>)]+l
+ k
2
y[l/( a, +a,)] w\"• /( a, +a,)Jw;[a, /(a, +a, )]+ 1
= ( kt + k
2
)yll/( a, +a,)lw\"•/( a, a, +a,)}
where k; = (a;/ai)la;/(a;+a;ll. Now, differentiating C' with respect to, say, w
1
yields
Now, verify that
l
7.
(::) 1 = (::).
Therefore, (8C' jßw!) = xj. Similarly, (8C' jßw2) =: x;.
(b) Solve the first equation in part (a) for FLK· Substitute into the second equation
for !KL (since hK = !KL)·
(c) In part (a), !LL < 0 implies hK > 0.
(e) From equation (713), factor out,\ from each of the first two rows; then factor out
1/.\ from the last column and 1 from the last row.
CHAPTER.9
3. In each part, the cost function can be checked first tobe sure it makes sense, i.e., that
it is homogeneous of degree one in w,, w
2
• Also, the production function which is found
can be verified by using it in the cost minimization problern and rederiving the original
cost function.
15
16
(a)
(b)
( c)
, 1 (W2) t >
Ct = x
1
=   e>
2 W!
, 1 (w•)! !
C2 = x
2
=   e .
2 W!
Rearrange x2 and substitute it into xj:
Substitute xj into x2: x2 = y +log(.\) or y = X2 + logx,.
•
c, = xj = yw, (wi + wn! = y (1 + ( ::)
2
).
Rearrange x2 and substitute it into xi:
4. By definition,
f(tx1, ... , txn1• Xn) S t' f(x1, ... , Xn).
By Euler's theorem:
n
I:; /;x; = rj(x1, ... ,xn)
n1
I:; /;x; = sf(x,, ... ,xn)·
i=l
Subtracting the second summation from the first leaves,
fnxn = f(xt, ... , Xn)(r s), or
(:;J Xn = y(r s).
Rearrange this to solve the differential equation:
17
18
oy = (r _ s) (ox.)
Y Xn
J
oy = (rs)J ox.
Y Xn
log y = (r s) log Xn +log (g(x,, ... , Xn_
1
)),. or
r• ( )
y=xn g Xt, ... ,Xn1
is the most general production function. If all x,'s have the same properties, the function
18
5. If y = f(x,, ... , :tn) = F(h(x,, ... , x.)) is homothetic, h can be homogeneous of degree
one in Zt, ... ,xn. If f is homothetic in x1, ... ,Xn1 also, then h must be homogeneaus
of some degree s in x
1
, ... ,Xnt· Thus, using Eulers theorem as in question 94,
h must have the form hf'x2' ... x:;•. Therefore, f(x
1
, ... ,xn) must have the form
... x!:").
7. If f = F(h(:c,,x2)), then fi = F'h, and fi; = F'h•; + F"h,h;. Substitutethese into
equation (!t28):
"= x,x,(f? fu 2fthft2 + fl !22)
(F' h,)(F' h,)[F' h
1
x
1
+
= x,x,[(F'h,)2(F'hu + F"hD 2(F'ht)(F'h,)(F'h
1
, +
.
. . . +(F'h
2
)
2
(F'h
22
+
Then, "= h,h,jh,,h when f is homothetic, since h is then homogeneaus of degreeone.
Intuitively, since for homothetic functions each isoquant is a radial blowup of the
others, the properties of any one isoquant reflect the properties of all isoquants.
CHAPTER 10
2. Upwardsloping or flat indifference curves imply that the consumer may be "" better
off when both goods are increased.
4. >.M = (Uj fpt) = (U2fp,). Since x; arehomogeneaus of degree zero, Ut = U;(xj'f, xr)
is also homogeneaus of degree zero in PI, P2 and M. Then,
>.M(tp tp tM). U;'(tp, 'tp,, tM)
1' 21  t
Pi
= c' Ut(p,, p,, M) .
P1
= t1>,M(Pt,P2,M)
5. From the firstorder conditions of the utility maximization model:
1
19
20
or ·
Substitute in Z2P2 = M "'tPt from the constraint
then
And, by symmetry,
Now Substitute zf' xr into
il i .
(
M)a'
= <>t ~ <>2 Pt
(
M)a'
<>t ~ "'' p,
and into
Differentiate u• with respect to M,
6. By Euler's Theorem for xf":
t (&;fl) Pi+ M = 0, i = l, ... ,n
J=l PJ .
I; (:!tr) (&xfl) + ( (&xfl) = 0
. X; &p
1
"; &M
J
L:eff+efL=O, i=l, ... ,n.
j
n &"1)1
LPi &!J = 1
;=t
" (x; M) &xtt
L.JPi  = 1
. Mx; &M
J
Differentiate the budget constraint with respect to p;:
n &xl)l M
LPiT+x; ::0, i=l, ... ,n
i=l p,
(10 53)
(10 54)
c:r) = xfl (10 59)
By Euler's Theorem for xY:
LKie.J1=Ki
1
i=l, ... ,n.
j
21
Y1
I
22
9.
n ({) M)
2:P; ;'. = 0,
n=l p
1
'2::: (Pi) (oxf) = 0
. x, op
1
1
(10 60)
'2::: ef; = 0, i = 1, ... , n.
j
Differentiate the constraint with respect to p;:
'tu;(
8
"'Y)=o, i=1, ... ,n.
i=l op,
Multiplylng by A,
LPi (axf) = o
j {)p,
2:Pi (P') ("i) (axf) =0 (1061)
. M x
1
{)p,
1
:L: tc;ef. = 0, . i = 1, ... , n.
j
LPiSik = l:PjSkj = 0
i j
LPiSik + Pk'kk = 2:PjSkj + PkSH = 0
i# j#
LPiBik = LPiSkj =·p.csu.
i;tlr: j#k
Then, since su < 0,
2:PiSik = 2:PjBkj > 0.
i# #k
(10 62)
23
11. This is just eq. (1022).
12. This is an application of Roy's identity and eqs. (1074) and (1075) for the demand
curves with endowments.
13. L = U(o:1,o:2) + >.(1 Pl"l p2o:2); The firstorder conditions are:
L1 = U1  >.p1 = 0
L2 = u2  >.p2 = o
(a) Using the firstorder conditions,
(
oU) M ( oU) M M M M M
0
"
1
"1 +
0
"
2
"2 = >. P1"1 + >. P2"2
= ,\M (PI"r + P2o:r)
= ,\M.
(b) By the envelope theorem,
(c):
(d) lf U(o:
1
,o:2) is homogeneaus of degree r, then by part (a),
However, using part (c), and then part (a),
:ll
I
\ ~
'
Ii
I.,
24
14.
 Pt+  P2 '= >.M = rU*.
(
au·) (au·)
8p, 8p,
Thus U*(Pt
1
P2) is homogeneaus of degree r by the converse of Euler's tbeorem.
= or U(zf!,zr)
= r'U*(Pt.P2)·
Tbe firstorder conditions are:
L, = U(  >.p, = 0
L2 ;", u ~  >.p2 = o
Lp = M PlZl p2Z2 = o.
The secondorder condition is
Uf'
D= 0 U!j p2 > 0.
or,
v = pw:· P W ~ > o.
Therefore,
u:' < 0, or u ~ < 0, or both.
(b) If U;' < 0, i=l,2,
25
(+)() > 0
(+) .
15. In the twogood model, the goods must be net substitutes, i.e., 8xlf f8pl > 0. From
the budget constraint (see the derivation of eq. (1059)),
8xt'f 8xf M
PI;;+ P2. =XI < 0.
VPI UPl
Since 8xt'f /ßP1 > 0, 8xf /8Pl < 0 is implied.
17.
subject to PlXl + ... + P•"'• = M.
The firstorder conditions include
Therefore, A = xdp2 = x3/P•·
The budget constraint thus becomes
or
26
By symmetry,
Adding,
where K = [(2PIP2 p ~ ) + (2PaP4  p ~ ) ] .
Also,
Note that &:x;f&p; 'f 0, i = 1,2; j = 3,4.
Lastly,
and &/" f&p; 'f 0, j = 3,4. Thus "twostage" budgeting is not implied, even by
strongly separable homothetic utility functions.
27
19.
?'I
(a) This postulates that
8
<g;[u,) > 0,
8
<g;!u,) < 0. Using the quotient rule,
 [U.(8Utf8xt) Ut(8U./8zt)]/U'f > 0
 [U.(8Utf8x•) Ut(au.;ax.)]/8Ul < o
or
Using the firstorder conditions of the utility maximization problern on the second
order condition:
Uu Uto Pt Ua ul2
 ~
D= u.!
u •.• p,
=
u.! u ••
 ~
PI pa 0
 ~  ~
0
= l/>.
2
[Ut(UaUat U1Uo2) Uo(UaUu UtUl2)]
28
which is positive, using the postulate.
(b) Assuming U1 U22  U2U12 > 0, then using the firstorder conditions:
then,
Assuming the opposite signs for [8(U
1
/U2/8o:;] implies D < 0, i.e., concave to the
OJ:igin indifference curve8.
(c) The converse of part (b).
( d) [8( U!/U2)/8o:2] > 0 implies [8( U2/Ul)j8x2) < 0. Increasing consumption of >:2.
(o:
1
constant) will increase wealtb, thus the marginal evaluation of o:
2
relative to >:1 will
increase wben 0:2 is normal and >:1 is inferior.
(3) The postulate only asserts that the Ievel curves in twodimensions are convex to the
origin. This may be true for all pa.irs of goods wbile the threegood indifference surfaces
are concave to the origin.
20. This problern utilizes the results of problern 19.
CHAPTER 11
1. Note th<>t
8>.M _ Dn+l,n+l _ (Ul'U; · · · u::J
8M D  D '
where >.M is the marginal utility of money income and Dis the usual bordered Hessian
determinant for the utility maximization model, except that the offdiagonal terms are
zero in the first n rows and columns. We have sign D = ( 1 )n by the secondorder
conditions. The sign of the numerator term is ( 1 )n if all UJ' > 0; otherwise it is
(1)nl. Thus, if Uf' < 0, a11 i, then (J).M j(}M > 0; otherwise it is negative (at most
one UJ' > 0). Now note that
i = l, ... ,n (1)
from which the conclusions ab out the income effects follow. Note also
U
!' 8:1J;  p,· (}). • .J. •
, {) Jr'·
8pJ Pi
(2)
Now
(3)
using eq. (1022). Using this and the results for the income effects yields the results
for the pure substitution effects.
2.(a) This is a simple consequence of (1) and (2) above.
(b) Substitute (1) into (3).
3. If V(r!, ... , rn) = V1(r1) + ... + Vn(r;,), then clearly u;,Pi = Vr
1
r
1
= 0 when i :f: j.
From Roy's identity,
Thus for i :f: j :f: k,
29
30
and the result follows by division.
4. Using this result and (2),
and, (see eqs. (1G63) and (1064) this quickly implies unitary income elasticities and
homotheticity.
8. This is of course a revealed preference question. Leo is violating the weak axiom.
9. (a)
10 = p
1
z
1
;:: p
1
z
2
= 0, z
1
rev. pref x
2
•
8 = p2z2 < p2zl = 10
14 = p
3
z
3
< p
3
z
2
= 17
The preferences are also transitive so this is consistent with utility maxmization.
(b) 21 = p
2
z
2
;:: p
2
z
3
= 18, z
2
rev. pref z
3
, but 28 = P"z
3
< p
3
z
2
= 27is false. Therefore,
this is inconsistent with the weak axiom and therefore also inconsistent with utility
maximizati9n.
(
( c)
'
"
10.
23 = p
2
x
2
;<: p
2
x
1
= 22, x
2
rev. pref x
1
18 = p
1
x
1
< p
1
x
2
= 19
23 = p
2
x
2
;;: p
2
x
3
= 20, x
2
ref. pref x
3
17 = p
3
x
3
< p
3
x
2
= 20
31
Consistent
Since this set of purchase bundles is intransitive, and therefore inconsistent with utility
maximization (i.e., irrational), the answer is obvious.
32
11.
P2 M
Xt = , X2 =  1, P2 < M
Pt P2
PtXt + P2X2 P2 [ (:) 11
=p2+Mp2
=M.
The budget constraint is satisfied, and the demand functions are homogeneaus of degree
zero, so s
1
2 = s21· Thus, a utility function exists. Solve Xt, x2 for Pt = [ z,(!!"+l)] , P2 =
[ (z:!t)], and plug into:
Integrate:
=
1
=
J 8x2 = J a:,t + f(U)
"'2 = log (xt) + f(U) or
U = g(x2 +log Xt)
12. Note that
[
P2M ] [ PtM ]
Pt"t + P
2
"'
2
= (Pt + P2) + (Pt + P2) E M
thus the budget equation is satisfied (as is homogeneity). Noting that
1
Jl
j
1
33
Pt"t P2
=
P2"2 Pt
we have
Integrating,
or
14. Let " be the good, Iet p
0
be some price at which the consumer. buys no " at all, and
p
1
the market price. We shall suppress the other prices. If the consumer is allowed ·
to purchase as much as he or she would like at price p
1
, utility U
1
is achieved. At
zero purchase of ", utility U
0
is achieved. The definitions of the first three r'neasures of
consumer's surplus are then:
1.
p'
 { "u• dp
}po
p'
 { "u• dp.
}p.
34
The integrals are all positive. Clearly, 2. > 1. always. If the good is normal, then since
ut > U
0
' .,f > .,yo and thus 3. > 2.
There are no unique monetary equivalents of the changes in utility in measures
4. and 5. except under special circumstances. If the indifference curves are vertically
parallel (see problern 15), then a given change in utility corresponds to a unique amount
of numeraire.
15. Inthis case we have n + 1 goods, x
0
,x
1
, ... ,xn, with prices 1 , p ~ . ... ,Pn· The line
integral yielding the consumer's surpluses is
j 1 dxo + t p;(x)dx;.
i.=l
In order for this line integral to be path independent, ~ =
8
W_<:
1
= 0, since p
0
= 1.
The Pi(x)'s represent the marginal value of x
0
in terms of Xj(M RS;J)· ~ = 0 means
that the slope of the indifference curves do not change as xo changes. With xo plotted
on the vertical axis and any "'i on the horizontal axis, this says the indifference curves
are vertically parallel, and hence ~ = 0, j = 1, ... , n.
CHAPTER 12
1.
(a)
(b)
In each case, "1+1 is a constant times o:;; if r > p, "1+
1
> o:;, i.e., consumption increases
over time since the premium for earlier availability exceeds the rate of impatience.
13
2. Initially, your consumption possibilities lie along AB. If the interest rate doubles, your
frontier pivots to AG; if half the complex burns, the frontier shifts to DG. Unless you
have no heirs and wish to consume your entire wealth immediately, you prefer the cause
to be a fall in the interest rate.
6. Suppose prices were to start doubling every year. Then depreciation would be seriously
understated, artificially increasing reported corporate profits and therefore corporate
taxes. The effects of the present rate of inflation are already capitalized into the price of
gold and depreciable assets. With greater than anticipated inflation, tbe relative price
of gold will increase. The capital gains exclusion for housing ameliorates this effect for
housing.
7. The text answer assumes constant nominal mortgage payments; with severe inflation,
we would expect to see indexed mortgages, alleviating this problem.
CHAPTER 14
3. The KuhnTocker conditions are:
35
The third edition of The Structure of Economics contains two brand new chapters. Chapter 15, Contracis and Incentives, and Chapter 16, Markets with Imperfect Information, cover the exciting recent developments in information economics. Wing Suen ofthe University ofHong Kong wrote these chapters. We discarded the old Chapter 19 on stability of equilibrium in order to accommodate this new material. Also discarded is most ofthe old Chapter 2, the calculus review, which we feel is no Ionger important. Wehave maintained, however, the discussion ofTaylor's series, and some topics that are not typically covered in elementary calculus courses, such as continuous compounding.
The traditional chapters of the text contain many emendations and clarifications, which we hope will prove useful. We discarded the very general primaldual analysis bf c~mparative statics presented as Sec. 7.5 in the second edition, these results being of little practical use, in favor of greater analysis of the more useful models where the parameters enter eilher the objective function or the constraint. We have striven to keep the informal tone of the text in both the old and new chapters, and to focus on deriving interestiflg and useful results, usmg the most elementary math that is required to do the job.
There is a tendency to treat comparative statics in a very terse manner, as though the whole subject could be summarized by the solution to the matrix equation (H)(&!oa) = (fxa). We, however, see comparative statics as the core methodology of economic science. As long as economists are not able to measure tastes and other important functions which determine behavior, the only scientific (i.e., refutable) propositions we can derive will be Statements about how decision variables change when parameters change, under the assumption of stability of those underlying functions. Thus the third edition to this text remains fiercely devoted to the goal of deriving refutable propositions from maximization hypotheses, and understanding the mathematical structures !hat yield these results.
CHAPTER 1
2. Assertions are those
b~havioral
postulates which we believe to be universally true, such
as "more is preferred to less,t' diminishing MRS, etc. Assumptions, on the other hand,
are the test conditions of a given expedment; they are true only at a given moment, e.g., the price of gasoline rose 20 cents a gallon at a certain time, etc. 4. This question is answered in the introductory paragraph. Of course, economists would Iove to be able to predict total quantities. This will be impossible as long as some
variables are not measured.
2
11. We will once again derive dx' Jdt < 0. This can be seen by setting R( x)
=0 in Example
1. Thus this theory yields the same refutable propositions as those in Examples 1 through 3.
13. The side of the can uses 1r Dh; the "waste," made up of .the· eight·corner pieces when a
circle is cut from two end squares, is k(2D 2
a

~1r( J?J')
= lcD (2 ~) :: kD2 a, where
2
=2 
~,
and where 0 ::; k :5 1 indicat~s the ability to recycle this material. The
objective function is thus
minimize
rrhD + 2D 2 kD 2 a

subject to Using the constraint to eliminate h,
rrD h=l. 4
2
minimize
~ + D 2 (2 ;_ ka)
"D
 rrD• +2D(2 ka)
=0 rrh + 2D(2 ka) = 0.
41r
or
Therefore
h
42ka
4k(4rr)
v=
When k = 0 (no recycling),
"
=
"
jj =
t; when k = 1 (no waste), jj = 1.
CHAPTER4 Section 4.2 3. For 0 < a,ß< 1,a+ß< 1,
ty = 0 1r2=MR2MC=O where M R.a. but rising. "t = M Rt  M C .3 YLL YKK YLLYKK.2. This problern has the same structure as the profit maximization problern with respect to a change in factor prices. We find. =a/L 2 < 0. lf <> + ß =1. Section 4.'.5 5. (c) This follows the profitmaximizing firm example exactly. YLLYkK = aß/L 2K 2 > 0. YKK 4. "117ft+ "127ft = 1 8yj 8y2 where the "'i 's are given as in Problem 6. YLL =ß/K 2 < 0·. 1r 12 = C"(y) = MG' 0. Section 4. similarly. the function is weakly concave.ß)L2a2K2P2 > 0. (a) ( b) The denominator is positive here.l)L"2 KP < 0 = ß(ß l)L"J(P2 < 0 = aß(l. Differentiating with respect to t. YLK = UKL =0. If marginal cost is J .YLK = <>(<>. = T R. then 8yif8t > 0.
. then this essentially becomes the onevariable monopalist of Chapter 1.2)/D<O. holding the number of shovels fixed will tend to reduce the firm's demand for ditchdiggers. it will not be possible to sign either 8yif8t or 8y2f8t. The parameter t enters both models identically. This result is known as the Edgeworth taxation paradox.4 Additional Comment: It is even the ease that {}y• f8t = 8yjf8t + 8y2f8t does not have a determinate sign: where D = 1<111<22.11 +1<2z2. 9. Unless the revenue and cost functions can be measured.ty1 . 7. only if the marginal revenue curve is downward sloping in market 2 (a condition not implied by profit maximization) will total output sold by this monopalist decrease in rcsponse to a tax increase. (b) If y 2 is held fixed. (a) {}y•fat= (.=MRtMCt=O . Since the parameter t enters 6oth firstorder relations. Letting D =1<111<22..2 =MR2MCt=O. hence. usingequation (48).ty 2 producing the firstorder relations. . (8yif8t)y. If the wage of ditchdiggers fall.~ 2 > 0. 8. The model is now maximize. 6. oyj I 8t < 0 is implied in both models and no other results are forthcoming.~2 .. Hence. =TR 1 + TR 2  C(y). < 0. Consider ditchdiggers and shovels. The objective function is .. these two models are observationally equivalent.
ilp Since 8:t2jow2 (~) · < 0. however.J!_  [)y' 8:t2 aw2 [)y' . since p is endogenous.g aw2 · Using the second equation to eliminate oy' I a.J!_ := .[)y' 8:t2 from the first.5 The first and secondorder conditions are .g = oy' j8w 2 == 8:t2f8p.op [)p . It makes no sense to ask about any other... and remembering that [) • [) ' _P_ (~)2 ap . in part (e). . =pft  w.. There are no comparative statics relations available for output price. =0.op o:t~ a. . that the factor demands are not homogeneaus of degree 1 in factor priees. There is an implied profitmaximizing output price. 12. oy' fop > oy' f8p.:'· = 10.?.(1 + t)w2 =0 ". output price is endogenous. nonimplied price. .upf" < 0' . This is an examination problem.. ~ 8=' W2f. being embedded in 11. = w1 7f (c) Differentiating the firstorder identities with respect to w2 and t.u D =p{!u/22 1[2) > 0. Note. note. The fundamental identity is Differentiating with respect to p and then [)y' . The objective function is The model is essentially the sru:ne as the text problem. .+ .[)y' W2.. however.. It follows the earlier monopolistic discrimination models.. 1r2 = pfa.
CHAPTER 6 1.. ßA• jßa = Hta/H = H. for ß it is (0.1 )' A' =I'= I.1 = I. (A.A. do this problern again. if c>. times the ratio of some borderpreserving principal minor of H to the whole Hessian determinant. Since Aa is also the determinant of an uppertriangular matrix.)'.tfH.0. APPENDIX 2. and 2. The result follows by substitution. Since ß enters two firstorder equations. 6. (Al)' = (A'). no refutable propositions are possible: ßzj ßß = A H21 _ x H 2 Hat H. = . These problems are straightforward generalizations of the text material. Apply matrix multiplication. (A'). 4. the result follows by induction.6 CHAPTER5 Text 2./ßa = Ht.1 • 5.. and thus the result follows. ßzjjßa H11 f H = > 0. The righthand matrix for"' is (1.1 on the right. using the duality results derived there. (b) Note that ßz'. Expanding by the first column: lAI = auAu.tfH./H = H..<h firstorder relation. However. The equivalence of 4( c) and 4( d) is shown in Chapter 10 in the text.L. Multiply (AB). In each case.x. but not a constraint. When Chapter 7 has been covered. H.1AB =I by s. 5. Taking the transpese of AA. Since inverses are unique. 8. This follows because AA' = I implies that A' A = I (taking the transpese of both sides). enters only the . Thus. then ßxi jßa. These two determinants must have opposite sign.0)'.1A. .1 A' =I by definition.
.8AC' f8x. (d) From firstorder conditions. from which the result fo!lows. AC.f8w. = . Note that 8(AC' f.j8w2.f. sii)ce 8AC' f8x. !12!2))/AC(f"h2 ff2) ~ 0. (b) Follows from second partials. (c) From the geometry in (a).xi+w2xi). = AC/. k cannot be varied without violating the constraint. xi(a).ff2) ~ 0. = + x. and sum the two equations.ff(h2f. (d) The primaldual problern is subject to g(x 1. and rPaa. This is not Euler's Theorem./AC' = wd' /(w. =AC'/..x2) =k .j8w. This result.8x. not for all x. Note that if x 1 and x 2 are held fixed. = 0. this follows the text exactly. and x 2) holds only lft the point of miilimum AC..o:)..!aa > 0.))/AC(!ld22. reverse . 8x2/8w2. x2.. CHAPTER 7 l(a) and (b).7 8. rPa(a) = fa. However.ff(!Hh. f.the ones and twos to get ax. an identify in w. multiply through by x.J. rPa(a) E /a(xi(o:). = w..f2. Differentiating both sides with respect to a. (c) 8x. and w2 (not x. Fora.)f8x./f. = (/22 (/21 + x.AC'/.
faa 0 ga J.<l>aa) >0 0 yields the only implied curvature property for </>.g. = <~>· +).</>aa H11.<l>aa </>ka 0 0 0 <Pak g.. = " c2  ).22 <Pak ·0 = </>u 1 1 = Uaa..<Pa= 0 c.g(z 1. =0 = 12.a ha faa. The third and fourth equations are the envelope theorem for <> and k. <l>aa (e) From <Pak= <l>ka.u2 = o Ca= Ja. =0 C>. g· 0 1 <Pu 1 0 The borderpreserving principal minor formed by eliminating the first two rows and columns. = k.8 producing the Lagrangian The firstorder conditions are c. The secondorder matrix ts c" c12 c•• C2a H= f1a 0 g.. faa. we have * = I!J:. . > !aa· Using d(1) and d(3).z2) = 0.).
2. however.:z:. 3.pter 8. This problern is worked out in Cha. It is a.:z:.l methodology of Cha. The reciprocity condition in (c) follows from using the results of part b. + w2:z:2 = k (a) 1t'• =7r' = L 81r' 81r' 8L 81r' 81r' ===aw. Campare with the tr11ditiona. :z:2. ="''. aw. 4.).. = :z:. w.9 from whieh the result follows by the implied differentiation. (f) Of eourse. for the parameter 01.t. :z:2) + OI:Z:l. tf>aa.>.(l + >. aw. useful exercise for students to do on their own.' f8k does not have an implied sign. 01) = h(:z:. This problern is a special case of problern 1.pter 6. aw. !aa E 0. aw. 8>.0 > 0. unless f is eoneave and g is convex in"'' and "'2· (g) lf /(:z:. . LongRun ShortRun: s. thus from (a) or (d)..
more elastic.\ = l?h.10 In longrun.\') llw1 >>+llw( llw( .\ = 0 from firstorder eonditions. llw1 > [ll(xf(l + .. llw. t he L. .\') . •~· ' ow. (c) However.. < 0. (~~:) + (~::) < 0 < 0 sinee ~ 0. therefore. the elasticities cannot be compared.\'))] > 0 llw1 1)2~· 1)2~• IJ2L llxi _ [ll(xl(l + . llw1 _(I+.=xj(! + . This doesn't imply ~ 8w. t here. if it is assumed that ~ < 0. Therefore. Therefore..ore.::J.· I Wt = ill W2 I. since ~ = '1rkw 1 == '1t':U 1 k = W. In shortrun. Therefore. or •·· ~ ••' < ~· 't...e.~ 8 8 "'' < "' (..) < 0. llw. ehr' .\') (llxf) llw 1 "' (b) Show~ . . "' "' ~.Rdeman d'1s . ~ = xi.\'))] = xj ( /). · ••' From the enveIope theorem.:. .
i.11 5.x. Thus 8 r=T· Integration yields log </> 84> 8k =log k +log a. This behavior is not observed. = ak. I: /. cost functions must consider additional behavioral assumptions and constraints.costminimization model should yield an interior solution.e.. Our observations refute the implications derived from the assumption of concavetothe<>rigin isoquants. . or </> CHAPTER 8 1. 2. Empirical reasons suggest that the . it says nothing about how a firm uses that technology. In order to be welldefined. a r</> a A' I: g. to be useful in deriving testable implications. With differing behavioral postulates.k. Such concave isoquants imply the firms will hire only one input. different costs will be associated with a given output Ievel. a A'rk 84> </> = k k. It is for this reason only that convex (to the origin) isoquants are postulated. which in turn implies that the isoquants be postulated tobe convex to the origin.ximization. The technology available to the firm is just one constraint facing the firm. such as wealth ma. The first<>rder conditions are Multiplying through by xt and summing.
.w.(f(x 1 .x 1 . 2(/u/22. H.12 5.>rofit maximizing Ievel of output. In particular. H..Z:t .) and Cramer's Rule.!(2 ) < 0..w 2 x 2 + >. The comparative statics are found using (L. !t !2 0 Its determinant.f 1 =0 The matrix of the second derivatives of L is 0 0 0 >. x2).y)]} (b) The inner minimum is precisely the cost minimization prob lern.(f(x 1 . the outer maximum specifies that this occurs at the .::2 y :l:l . (c) The first order conditions of the Lagrangian are: L. + >.x.. y . = w..x 2 ) . must be positive.. w 2x 2 + >.. the reciprocity condition falls out directly: . (a) 1r• = max{maxfpy. must be negative and its secondorder borderpreserving principle minors.t:. Expanding H by the first column and then by the remairring first row yields H = >.!12 1 (L.y)]} = max{py+ max[w.) = o Vu 1 .
6.13 The supply slope follows from the signs given by the second order conditions. then . ßy• ßp =_H 11 _ _ ( +) > H () 0' These results also follow immediately from the theorems of Chapter 7. Salve the first order conditions of the Lagrangian From the first two conditions or Substitute this into the constraint.
)Jw.+a. +a.)lw\"•/( a. +<>>)]W~a. +a./(a. +a. +a. +a. C' is found by substituting xi.f(a.f( a. +a./(a. by summetry. = (a.14 And x. Now./ai)la.)}W~a. differentiating C' with respect to.)}W~[a. x. +a. can be found directly. w1 yields Now. say. +a>)]+l + k2y[l/( a. /(a. )]+ 1 = (kt + k2 )yll/( a.)] w\"• /( a.)} where k. verify that .[a. into = kt yll/( a.ll.
9 3. (b) Solve the first equation in part (a) for FLK· Substitute into the second equation for !KL (since hK = !KL)· > 0. the cost function can be checked first tobe sure it makes sense. factor out.. (8C' jßw2) =: x. !LL < 0 implies hK (e) From equation (713). In each part. CHAPTER.. l . the production function which is found can be verified by using it in the cost minimization problern and rederiving the original cost function. (8C' jßw!) = xj. Therefore. then factor out 1/.e. w2 • Also.. i.\ from each of the first two rows. Similarly. (c) In part (a).\ from the last column and 1 from the last row. that it is homogeneous of degree one in w.15 ( : : ) 1 = (::). 7.
. = xj = yw.\) or y = X2 + logx.(w•)! e! .1 2 W! (W2) t e> > C2 1 = x.2 = . • ).= y (1 + ( ::) 2 Rearrange x2 and substitute it into xi: .16 (a) 1 Ct = x . 2 W! Rearrange x2 and substitute it into xj: (b) Substitute xj into x2: x2 (c) = y +log(. = . (wi + wn!. c.
.. =rj(x1. Rearrange this to solve the differential equation: . By definition. or (:. . txn1• Xn) S t' f(x1. . fnxn = f(xt.x.. Xn).. = sf(x. .x.17 4. .J Xn = y(r. . By Euler's theorem: I:... f(tx1.s). . .xn) I:... ... .. n1 i=l n /.s).xn)· Subtracting the second summation from the first leaves. Xn)(r. . /.
h.. then h must be homogeneaus of some degree s in x 1 ... If f is homothetic in x1. :tn) = F(h(x..xn..) Y Xn J oy = (rs)J ox..Xnt· Thus.. If all x. x:..Xn1 ) is the most general production function. .. . = F'h•. then fi = F'h. the function 18 5.. .Xn1 also. . .. using Eulers theorem as in question 94.. h must have the form hf'x2' .. ... f(x 1 . Xn_ 1 )). .x2)). . .. . + F"h. h can be homogeneous of degree Zt.18 oy = (r _ s) (ox.. x. . x!:"). Substitutethese into equation (!t28): . If y = f(x. and fi. Y Xn log y = (r.. 7..xn) must have the form F(kxf 1 x~' ..'s have the same properties. If f = F(h(:c. . .. one in . Therefore.. or r• y=xn g (Xt.. .s) log Xn +log (g(x.. ...•.)) is homothetic.
. arehomogeneaus of degree zero. p.'(tp.P2.M = (Uj fpt) = (U2fp.M) 5.h.)[F' h 1 x 1+ 1. . tM) 1' 21 t = c' Ut(p. P2 and M.2fthft2 + fl !22) = x.). 4.x.)(F'h F'~x. >. >. M) .(xj'f.1 19 "= x. From the firstorder conditions of the utility maximization model: . since for homothetic functions each isoquant is a radial blowup of the others.] (F' h. ..M(tp tp tM). 'tp. P1 Pi = t1>. CHAPTER 10 2. F"h~)J + F"h 1 ~ 2 ) ..x. +(F'h 2 ) 2 (F'h 22 + Then. Upwardsloping or flat indifference curves imply that the consumer may be "" better off when both goods are increased.(f? fu. xr) is also homogeneaus of degree zero in PI.)2(F'hu + F"hD.[(F'h. Since x. . the properties of any one isoquant reflect the properties of all isoquants. Ut = U.M(Pt. "= h.. U.)(F' h.jh.h when f is homothetic.2(F'ht)(F'h. since h is then homogeneaus of degreeone. Then. Intuitively.
Now Substitute zf' il i . by symmetry. M)a' and into . xr into = (<>t ~ <>2 Pt M)a' ( <>t ~ "'' p."'tPt from the constraint then And.20 or · Substitute in Z2P2 = M.
.J1=Ki By Euler's Theorem for i=l. (&xfl) =0 ~) &M i=l.= 1 L.n. &M J . i=l &xl)l p.: n LPiT+x. .M) &xtt Mx..n.Y1 I 21 Differentiate u• with respect to M.=t LPi &!J = 1 (10. xY: .. 6. PJ (~t) M =0.54) Differentiate the budget constraint with respect to p. X.. (x.fl) J=l Pi+ . ::0.JPi . . . n &"1)1 ". .n ~Pi(~)(:. . i =l. .. . J (&xfl) &p1 j + ( ". L:eff+efL=O. By Euler's Theorem for xf": t (&. .n (10..53) I.) c:r) j = xfl (~) 1 (10 59) LKie. (:!tr) . M i=l... .
Multiplylng by A.. since su < 0. op n ({) 1 (10. . j 2:Pi (P') ("i) .csu. j =0 . #k .. = 0. LPi (axf) = o {)p. = 0.'. .( 8op. i=l i=1. .tlr: j#k Then. n. n=l p '2::: (Pi) (oxf) = 0 . "'Y)=o.. = 1.. i.62) LPiBik = LPiSkj =·p. 9. .. Differentiate the constraint with respect to p. 2:PiSik i# =2:PjBkj > 0. = 0.ef. LPiSik i = l:PjSkj = 0 j LPiSik + Pk'kk = 2:PjSkj + PkSH = 0 i# j# (10..n.: 'tu.22 M) 2:P. x. M x 1 1 (axf) {)p. i (1061) :L: tc. n. . j = 1.60) i 1 1 '2::: ef. . .
p2o:2).p2 =0 =u2  =o (a) Using the firstorder conditions. using part (c). (c): (d) lf U(o: 1. then by part (a). 12.p1 >. .o:2) + >. (1022). This is just eq. oU) (0" 1 "1 M + ( 0" 2 oU) "2 M =>.:ll I 23 11. M P2"2 = . However.\M. (1074) and (1075) for the demand curves with endowments. L = U(o:1. The firstorder conditions are: L1 L2 = U1  >.o:2) is homogeneaus of degree r.\M (PI"r + P2o:r) M P1"1 M . (b) By the envelope theorem. and then part (a). = M + >.Pl"l.(1. This is an application of Roy's identity and eqs. 13.
zr) = r'U*(Pt. .2. (b) If U. '= >.24 (au·) (au·) . or u~ < 0.p. Thus U*(Pt 1 P2) is homogeneaus of degree r by the converse of Euler's tbeorem.PlZl p2Z2 =o.P2)· 14.PW~ > o.P2 8p. =0 L2 . Uf' The secondorder condition is \~ Ii ' D= 0 U!j p2 > 0.' < 0. = U(  >. i=l. = or U(zf!.p2 =o Lp =M. u:' < 0.. Therefore.>. ... Tbe firstorder conditions are: L.". or both. or.M =rU*. v =pw:· . u~ .Pt+ 8p. I.
17. (1059)).e. + P•"'• = M... 8xlf f8pl > 0.+ P2.. the goods must be net substitutes. i. PI. From the budget constraint (see the derivation of eq.. 8xf /8Pl < 0 is implied.. In the twogood model. subject to PlXl + . A = xdp2 = x3/P•· The budget constraint thus becomes or .25 (+)() > 0 (+) . 15. The firstorder conditions include Therefore.=XI 8xt'f VPI 8xf UPl M < 0. Since 8xt'f /ßP1 > 0.
2.4. 'f 0. and &/" f&p. Lastly. = [(2PIP2.26 By symmetry. .f&p. even by strongly separable homothetic utility functions. i = 1. Note that &:x. 'f 0.p~) + (2PaP4  p~)]. where K Also. j = 3. j = 3. Thus "twostage" budgeting is not implied. Adding.4.
.! ~ 0 0 ~ ~ = l/>.!u.) < 0.ax.27 19.Ut(au. Using the quotient rule. ?'I (a) This postulates that 8 <g.) > 0.(8Utf8x•).• PI pa = u.(8Utf8xt).Uo(UaUu./8zt)]/U'f > 0 .U1Uo2). 2 [Ut(UaUat. 8 <g.[u.! u•.)]/8Ul < o or Using the firstorder conditions of the utility maximization problern on the secondorder condition: Uu Uto Pt p.Ut(8U..UtUl2)] . Ua ul2 u •• ~ D= u.[U.[U.
CHAPTER 11 1. Increasing consumption of >:2. Note th<>t 8>.irs of goods wbile the threegood indifference surfaces are concave to the origin.. then using the firstorder conditions: then.M _ Dn+l. This problern utilizes the results of problern 19. This may be true for all pa. (c) The converse of part (b). ( d) [8( U!/U2)/8o:2] > 0 implies [8( U2/Ul)j8x2) < 0. thus the marginal evaluation of o: 2 relative to >:1 will increase wben 0:2 is normal and >:1 is inferior.n+l _ 8MD  (Ul'U. · · · u::J D ' where >.U2U12 > 0. (o: 1 constant) will increase wealtb. 20. Assuming the opposite signs for [8(U1 /U2/8o:. i. (3) The postulate only asserts that the Ievel curves in twodimensions are convex to the origin.] implies D < 0. except that the offdiagonal terms are .M is the marginal utility of money income and Dis the usual bordered Hessian determinant for the utility maximization model.e. concave to the OJ:igin indifference curve8. (b) Assuming U1 U22 .28 which is positive. using the postulate.
a11 i. Thus for i :f: j :f: k. r From Roy's identity. then clearly u. We have sign D = (1 )n by the secondorder UJ' > 0.M j(}M > 0. Thus.. . + Vn(r. (1022). rn) = V1(r1) + . . (b) Substitute (1) into (3). 2. • (2) (3) using eq. Using this and the results for the income effects yields the results for the pure substitution effects...J.Pi = Vr 11 = 0 when i :f: j. Note also (}). .29 zero in the first n rows and columns... if Uf' < 0.. 3. otherwise it is (at most conditions.). U. Now note that i = l.(a) This is a simple consequence of (1) and (2) above.. then one (J). . .!' 8:1J. otherwise it is negative UJ' > 0)..n (1) from which the conclusions ab out the income effects follow. If V(r!. .p.· {) 8pJ Pi Now Jr'· • . The sign of the numerator term is ( 1 )n if all (1)nl.
Using this result and (2). but 28 =P"z3 < p3z 2 =27is false.:: p 2z 3 =18. z 1 rev. (a) 10 = p 1z 1 . pref x2 • 8 =p2z2 < p2zl = 10 14 =p z 3 3 < p3 z 2 = 17 The preferences are also transitive so this is consistent with utility maxmization.:: p 1z 2 = 0. pref z 3. and. 9. 4. This is of course a revealed preference question. this is inconsistent with the weak axiom and therefore also inconsistent with utility maximizati9n. Therefore. (1G63) and (1064) this quickly implies unitary income elasticities and homotheticity. Leo is violating the weak axiom. 8. z 2 rev. (see eqs.30 ( and the result follows by division. (b) 21 =p2z 2 . .
x 2 rev.31 (c) ' " 23 18 =p2 x 2 .e. and therefore inconsistent with utility maximization (i. . x 2 =p 1 x 1 < p 1x 2 = 19 = p2 x 2 . irrational). the answer is obvious.. pref x 1 Consistent 23 17 ref.: p 2x 3 = 20..<: p2 x 1 =22. pref x3 =p x 3 3 < p3 x 2 =20 10. Since this set of purchase bundles is intransitive.
Solve Xt. Pt X2 M = .(!!"+l)] . and the demand functions are homogeneaus of degree zero.t + f(U) or =log (xt) + f(U) U = g(x2 +log Xt) Pt"t + P2"' 2 =[ (Pt + P2) + P2M ] [ PtM ] (Pt +P2) E M thus the budget equation is satisfied (as is homogeneity). x2 for Pt = [ z. P2 < M P2 1 Jl PtXt + P2X2 =Pt(:~)+ P2 [ ( : ) 11 =p2+Mp2 =M. a utility function exists. The budget constraint is satisfied. so s 12 = s21· Thus. and plug into: = =Integrate: 1 J 12.32 11. Note that 8x2 "'2 = Ja:.1. Noting that . P2 = [(z:!t)]. Xt P2 =.
. utility U1 is achieved.33 j 1 we have Pt"t P2 =P2"2 Pt Integrating. utility U0 is achieved.}po "u• dp { . Iet p0 be some price at which the consumer.{ "u• dp. }p. buys no " at all. We shall suppress the other prices. The definitions of the first three r'neasures of consumer's surplus are then: 1. Let " be the good. If the consumer is allowed · to purchase as much as he or she would like at price p 1. and p 1 the market price. At zero purchase of ". or 14. p' p' .
yo and thus 3.f > . 8 0 The Pi(x)'s represent the marginal value of x 0 in terms of Xj(M RS. With xo plotted on the vertical axis and any "'i on the horizontal axis. with prices integral yielding the consumer's surpluses is 1. . 15.. If the good is normal.x 1 .Pn· The line j 1 dxo + t p. i. (a) (b) . j = 1. > 2. ~ = W_<:1 =0.J)· ~ = 0 means that the slope of the indifference curves do not change as xo changes. except under special circumstances.=l In order for this line integral to be path independent... > 1.. .. .xn. . CHAPTER 12 1. and 5.. . 2..p~. and hence ~ = 0. Inthis case we have n + 1 goods. There are no unique monetary equivalents of the changes in utility in measures 4. since p = 1. n. If the indifference curves are vertically parallel (see problern 15)... then since ut > U0 ' . x 0 . . this says the indifference curves are vertically parallel. Clearly. always.(x)dx.34 The integrals are all positive. then a given change in utility corresponds to a unique amount of numeraire.
with severe inflation. you prefer the cause to be a fall in the interest rate.. The KuhnTocker conditions are: .35 In each case.e. tbe relative price of gold will increase. 6. Then depreciation would be seriously understated.. alleviating this problem. consumption increases over time since the premium for earlier availability exceeds the rate of impatience. we would expect to see indexed mortgages. "1+ 1 > o:. Initially. if half the complex burns. 13 2. With greater than anticipated inflation. Suppose prices were to start doubling every year. the frontier shifts to DG. 7. your frontier pivots to AG. CHAPTER 14 3. your consumption possibilities lie along AB. The capital gains exclusion for housing ameliorates this effect for housing.. "1+1 is a constant times o:. if r > p. i. If the interest rate doubles. The effects of the present rate of inflation are already capitalized into the price of gold and depreciable assets. The text answer assumes constant nominal mortgage payments. artificially increasing reported corporate profits and therefore corporate taxes. Unless you have no heirs and wish to consume your entire wealth immediately.