API 111 / Econ 2020a / HBS 4010

Maciej H. Kotowski / Harvard University

Problem Set 5
Due: November 10, 2014 at 13.00

Legibly write your name (and the names of any collaborators) on your independently written-up solutions.
Submit your solutions to the assignment drop box. Do not bring solutions to lecture.
Show your work. Include brief and precise explanations of intuition and derivations as appropriate.
Help us out.

Enclose final answers with a box.

1. Top Trading Cycles and the House Allocation Problem

Consider the house allocation problem (i.e. the house exchange game from class). Assume agent i initially
owns house number i. Each agent has a strict preference over the set of houses, i . He may like others
houses more or less than his initial endowment. Each agent can consume at most one house. Suppose there
are 10 agents with preferences given by the following table:
Agent
1
2
3
4
5
6
7
8
9
10

Ranking of Houses
5, 3, 2, 6, 7, 10, 2, 1
5, 3, 1, 10, 9, 2
1, 10, 5, 4, 9, 3
1, 10, 5, 8, 9, 4
6, 2, 1, 9, 8, 5
1, 8, 9, 7, 5, 2, 6
8, 9, 10, 4, 5, 7
10, 9, 1, 2, 5, 8
7, 9
5, 7, 4, 2, 1, 9, 10

That is, Agent 1 has preferences 5 1 3 1 2 1 . All houses not listed are assumed to be strictly worse
than the agents initial endowment.
a) Find an allocation of houses that is in the core.
b) Offer an argument proving that your proposed allocation is a core allocation. (This reasoning was sketched
in class already.)

2. An Exchange Equilibrium with Cobb-Douglas Preferences

Consider an Edgeworth box economy. The preferences of agent 1 are u1 (x11 , x21 ) = x11 x21 . The preferences
of agent 2 are u2 (x12 , x22 ) = x12 x22 . The endowment of agent 1 is 1 = (10, 4). The endowment of agent 2
is 2 = (4, 6).
a) Find the set of Pareto-optimal allocations.
b) Which allocations are in the core?
c) Find all Walrasian equilibria in this economy.

3. An Exchange Equilibrium with Linear Preferences

Consider an Edgeworth box economy. The preferences of agent 1 are u1 (x11 , x21 ) = x11 +x21 . The preferences
of agent 2 are u2 (x12 , x22 ) = 2x12 + x22 . The endowment of agent 1 is 1 = (10, 4). The endowment of agent
2 is 2 = (4, 6).
a) Find the set of Pareto-optimal allocations.
1

b) Which allocations are in the core?

c) Find all Walrasian equilibria in this economy.

4. An Exchange Equilibrium with Leontief Preferences

Consider an Edgeworth box economy. The preferences of agent 1 are u1 (x11 , x21 ) = min{x11 , x21 }. The
preferences of agent 2 are u2 (x12 , x22 ) = min{6x12 , x22 }. The endowment of agent 1 is 1 = (10, 0). The
endowment of agent 2 is 2 = (0, 30).
a) Find the set of Pareto-optimal allocations.
b) Which allocations are in the core?
c) Find all Walrasian equilibria in this economy.
Hint: You may wish to illustrate your answers to parts a)c) in an Edgeworth box rather than writing them
out formally. In part c) there may be more than one equilibrium.
5. Multiple Exchange Equilibria
Suppose that there are two consumers in an exchange economy with two goods. The initial endowments for
these consumers are 1 = (2, 27 ) for consumer 1 and 2 = ( 27 , 2) for consumer 2. Consumer 1 has utility
1
function u1 (x11 , x21 ) = x11 2x12 , while consumer 2 has utility function u2 (x12 , x22 ) = 2x
2 + x22 .
21

12

a) Verify that each agents utility function is quasi-concave.

b) Normalize the price of good 1 to p1 = 1. Find the demand functions of agent 1 and 2 as a function of p2 .
Find the equilibrium prices and allocations. (There are three distinct equilibria.)
c) Can you Pareto rank the equilibria? Does any equilibrium Pareto dominate the others?
d) Let x11 (1, p2 ) and x12 (1, p2 ) be the demand functions for good 1 of agents 1 and 2 as a function of the
price of good 2. (The price of good 1 is normalized such that p1 = 1.) Graph these functions. Also, plot
the excess aggregate demand1 for good 1:
Z1 (1, p2 ) = x11 (1, p2 ) + x12 (1, p2 ) (11 + 12 ).
Use these graphs to explain why excess demand is not monotonic in p2 and as a result, why there are
multiple equilibria.

Additional Practice Problems (Do Not Hand In)

6. The Core of an Exchange Economy
Consider an economy with two goods and three agents. Their utility functions and endowments are
u1 (x11 , x21 ) = x11 x21 ,

1 = (8, 2)

u2 (x12 , x22 ) = x12 x22 ,

2 = (2, 8)
u3 (x13 , x23 ) = min{x13 , x23 },
3 = (6, 4)

1 Excess demand is just the difference between the demand of a good and its supply as a function of prices. In an economy
without production, the supply of a good equals the economys aggregate endowment of that good.

a) Verify that the allocation x1 = (6, 5), x2 = (6, 5), x3 = (4, 4) is feasible, Pareto optimal, and individually
rational for every agent.
b) Is the allocation from part (a) in the core?

7. An Edgy Equilibrium (?) in Edgeworths Exchange Economy

Edward and Eunice live in an Edgeworth box economy. There are only two goods. Edwards utility function
is u1 (x11 , x21 ) = 10 log(x11 ) + x21 . His endowment is 1 = (0, 5). Eunices utility function is u2 (x12 , x22 ) =
x12 + 5 log(x22 ). Her endowment is 2 = (10, 0).
a) If a Walrasian equilibrium exists in this economy, find it. If a Walrasian equilibrium does not exist,
explain why.
b) Sketch an Edgeworth box illustrating your conclusions from part (a). In your diagram, identify the set
of Pareto-optimal and core allocations.
Your diagram should be at least 1/2 of a page in size.