Final Exam

Quantitative Technique
Dec 11, 2017

Prof. Swagata Bhattacharjee

Instructions. Maximum score= 120. You have 2.5 hours to complete the exam. Good luck!

1. (30 points) Suppose an economy has 300 units of labor L; and 450 units of land K:
These can be used in the production of wheat and corn. Each unit of wheat production requires 2
units of L and 1 unit of K. Each unit of corn production requires 1 unit of L, 2 units of K.

(a) (5 points) With the horizontal axis depicting units of wheat (x) and vertical axis depicting units
of corn (y) , graph the land and labor constraints in two diagrams.
(b) (3 points) Indicate the feasible set, label the maximum output of x and maximum output of y.
(c) (10 points) Suppose the social objective is to maximize the social welfare function

U S = a log x + (1 a) log y
0 < a<1

Write down the maximization problem with all the constraints. Does a solution exist to this
problem? Write the Kuhn-Tucker Conditions including the complementary slackness conditions.
(d) (12 points) For a = 12 ; solve the maximization. Clearly mention if SOCs are satis…ed.

2. (10 points)

(a) A …rm has technology characterized by the production function

f (x1 ; x2 ) = x1 + x2

where xi = amount of input i used

The input prices are given by w1 ; w2 > 0:
The …rm solves cost minimization (minx2R2+ w:x subject to f (x) y) to obtain the following
cost-minimizing input demand correspondence:
8 w1
< 0 if w 2
>1
w1
x1 = [0; y] if w =1
: 2
y if w
w2 > 1
1

w1
Treat x1 : P (R+ ) as a correspondence from the set of all possible w 2
2 to the subsets of
the positive real line. Show that this input demand correspondence is upper hemicontinuous.
(b) Do the conditions for theorem of maximum hold in the previous case? Comment.

3. (30 points) Consider the principal-agent problem, where the agent chooses her e¤ort e 2 f0; Eg; E > 0
in order to produce an output.
Choosing an e¤ort involves cost c = e:
Output level depends stochastically on the choice of e¤ort. In particular, output level q is distributed
over the range [0; Q], and the associated pdf is f0 (q) if the chosen e¤ort is e = 0; and it is fE (q) if the
chosen e¤ort is e = E:
The principal can not observe the e¤ort choice, but can observe the output level q; so he has to design
a wage contract based on q; given by: w(q):
The agent’s expected utility from choosing e¤ort e is given by:
Z Q
u(w(q))fe (q)dq e
0

1
 The principal wants to induce the agent to choose e = E; hence he solves the following constrained
maximization problem:
Z Q
max (q w(q))fE (q)dq
w(q) 0
Z Q
st u(w(q))fE (q)dq E 0 (1)
0
Z Q Z Q
u(w(q))fE (q)dq E u(w(q))f0 (q)dq (2)
0 0

(The …rst constraint is called the “participation constraint”, so that the agent accepts the wage contract;
the second one is called “incentive compatibility”constraint, ensuring that the agent indeed optimally
chooses e = E:)
Assume the following:

u( ) is strictly increasing and strictly concave

The ratio
fE (q) f0 (q)
l(q) =
fE (q)
is a strictly increasing function of q:

(a) (5 points) Set up a Lagrangian for this problem. Denote the multipliers by and respectively.
(b) (10 points) Take the FOC with respect to w(q) for a given q: Show that the FOC can be rewritten
as:
( + l(q))u0 (w(q)) = 1 (3)
(c) (5 points) Using 3 write w(q) as an implicit function of q: Can w(q) be expressed as a C 1 function
around the given q?
(d) (10 points) Use Implicit Function Theorem to show that as q increases, w(q) should increase.

4. (10 points) Solve the following optimization:

min f (x) = x
Such that g(x; y) = y 2 + x4 x3 = 0

Can you use Lagrange? Why or why not?

5. (10+10+10+10=40 points) Prove (generally) or disprove (by …nding a suitable counterexample) the
following statements:

(a) Every concave function is quasi-concave, but not all quasi-concave functions are concave.
(b) Let f : Rn ! R be a continuous function and g : Rn ! R be another function. De…ne
h = f (x):g(x): If g is not continuous, h can never be continuous.
(c) Let D = [0; 1] and f : D ! R is an increasing function. Then f (D) is compact.
(d) Let C = [n2N [2n; 2n + 1] (where N = the set of natural numbers). For all z 2
= C; there exists a
separating hyperplane H = fxjp:x = ag such that p:x > a for all x 2 C and p:z < a:
(Hint: Check the conditions for separating hyperplane theorem)