Homework 10

Mathematics for Economics

Section 14.7 in page 516-517: #1 and #5

#5 (Hint: Use first two equations in FOC to find the relationship between L and K (and to
eliminate λ)). #6 (Hint: use Young’s Theorem)

1. Consider a consumer’s problem:

max u(x) s.t. p · x = I,
x
where p · x is the inner product of two vectors p = (p1 , ..., pn ) and x = (x1 , ..., xn ).
a. What are the first-order conditions.
b. Show that if I > 0, then the constraint qualification is satisfied.
c. Show that if u(x) is concave, then the solution of the first-order conditions x∗ is the
solution of the problem.

2. In the consumer’s problem that follows, α, β, γ, pi and I are positive:

max u(x, y, z) = xα y β z γ s.t. px x + py y + pz z = I.
x,y

a. Show that the objective (utility) function is a homogeneous function, and find the
degree.
b. Find x∗ , y ∗ and z ∗ (Hint: In the first three equations in first-order condition (say,
equation 1, 2, 3), (i) rewrite 1 and 2 to find py y in terms of px x, and (ii) rewrite 1
and 3 to find pz z in terms of px x. Then, use the budget constraint to find x∗ ).
c. Show that demand functions, x∗ (px , py , pz , I), y ∗ (px , py , pz , I) and z ∗ (px , py , pz , I), are
homogeneous of degree zero.
d. Suppose now that the objective function is u(x, y, z) = α ln x + β ln y + γ ln z. Show
that the solution is the same as above and explain why.

3. Suppose that a firm uses L as an input, and its production function changes with L and
a parameter a. Thus its profit is given by
π = pf (L, a) − wL,
where f is increasing in a, and where p, w > 0. Using Envelope Theorem, find the
derivative of the firm’s maximal profit with respect to a and determine the sign of the
derivative.

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4. Consider the problem:
max xa y s.t. 2x + y = 12.
x,y
a. Find all the solutions that satisfy the first-order conditions.
b. Let f ∗ (a) = f (x∗ (a), y ∗ (a)) be the optimal value function. Using Envelope Theorem,
∗
find dfda(a) .

5. Suppose that a consumer’s problem is given by

max u(x, y) = α ln x + β ln y s.t. px x + py y = I,
x,y
where α, β, px , py , I > 0.
a. Using the first-order conditions, find x∗ (px , py , I) and y ∗ (px , py , I) that solve the prob-
lem.
b. Using the second-order conditions, show that x∗ (px , py , I) and y ∗ (px , py , I) solve the
problem (global max).
c. Find the optimal value function v(px , py , I), defined as
v(px , py , I) ≡ u(x∗ (px , py , I), y ∗ (px , py , I)).
d. Show that v(px , py , I) is homogeneous of degree zero with respect to px , py and I.

6. Consider again the consumer’s problem in question 5.

a. Find the Lagrange multiplier at the solution (λ∗ ) and explain briefly what it means.
b. Using the Envelope Theorem, find
∂v(px , py , I) ∂v(px , py , I)
and .
∂α ∂β
√
7. Suppose that a firm produces a good with the production function f (L, K) = LK. The
firm wants to produce q, given that w and r are input prices and p is output price. The
firm thus minimizes the cost:
√
min C = wL + rK s.t. LK = q.
L,K

a. Find the optimal choices, L∗ (w, r, q) and K ∗ (w, r, q).

b. Verify that the choices are global minimum point.
c. Define the minimal cost C ∗ = wL∗ (w, r, q) + rK ∗ (w, r, q). Find
∂C ∗ ∂C ∗ ∂C ∗
, and , when w = r = q = 1.
∂w ∂r ∂q

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8. A consumer earns income a in period 1 and b in period 2. Her problem of finding optimal
consumption expenditure as follows:
c2 b
max ln c1 + ln c2 s.t. c1 + =a+ ,
c1 ,c2 1+r 1+r
where c1 and c2 represent consumption expenditure in period 1 and 2.
a. On the space of c1 and c2 , draw the budget line and find its slope. Explain the
meaning of the slope.
b. Show that the constraint qualification is satisfied, for us to use the Lagrangian
method.
c. Find the optimal choice (c∗1 , c∗2 ).
d. Show why (c∗1 , c∗2 ) in (c) solves the problem.
e. Now suppose that the consumer earns zero income in period 1 and earns a(1 + r) + b
in period 2. Find (c∗1 , c∗2 ). Compare this result to your answer in (c) and explain your
comparison.