Solutions Manual for ANDREU MAS-GOLELE MICHAEL D. WHINSTON LUO) Lael Chiaki Hara Ilya Segal Steve TadelisCHAPTER 1 L.B.1 Since y > z implies y » 2, the transitivity implies that x » 7 Suppose that z x x. Since y x z. the transitivity then implies that y x x, But this contradicts x > y. Thus we cannot have z > x. Hence x > z. 1.B.2 By the completeness, x > x for every x € X. Hence there is no x © X such that x x ippose that x > y and y > z, then x > y yz By (iii) of Proposition 1.B.1, which was proved in Exercise 1.B.1, we have x > z. Hence > is transitive. Property (i) is now proved. As for (ii), since x x x for every x € X, x ~ x for every x € X as well. ‘Thus ~ is reflexive. Suppose that x ~ y andy ~z Then x¥ryye7%yEX and z x y. By the transitivity, this implies that x x z and z x x. Thus x ~ 2. Hence ~ ie transitive. Suppoce x that ~ y. Then x xy andy yx Thus y x x and x yy. Hence y ~ x. Thus ~ is symmetric Property (ii) is now proved. 1B.3 Let *¢ X and yc X. Since u(+) represents >, x » y if and only if u(x) = uly). Since f(-) is strictly increasing, u(x) = uly) if and only if v(x) = vly). Hence x > y if and only if v(x) = vly). Therefore vi-) represents y. 1.B.4 Suppose first that x > y. If, furthermore, y x x, then x ~ y and hence u(x) = uly). If, on the contrary, we do not have y > x, then x > y. Hence u(x) > u(y). Thus, if x » y, then ule) = uly). Suppose conversely that u(x) = u(y). If. furthermore, u(x) = u(y), then ix y and hence x » y. If, on the contrary, u(x) > uly}, then x > y. and henee x x y. uly), then x x y. So ul+) represents >. 1.B.S. First, we shall prove by induction on the number N of the elements of X that. if there is no indifference between any two different elements of X, then there exists a utility function. If N = 1, there is nothing to prove: Just assign any number to the unique element. So let N > 1 and suppose that the above assertion is true for N - 1. We will show that it is still true for N. Write X = Gy, *y-p%y) By the induction hypothesis, x can be represented by a utility funetion u(-) on the subset (xp.-y_,) - Without loss of generality we can assume that u(x,) > ulx,) >... > ulxy_,) Consider the following three cases: Case 1: For every i < N, x, > Case 2: For every 1 < Ny x, > Hy, Case 3: There exist i < Nand Jj <¢ N such that x, > Hy > x; Since there is no indifference between two different elements, these three cases are are exhaustive and mutually exclusive. We shall now show how the value of ulx,) should be determined, in each of the three cases, for u(-) to represent ¢ on the whole x. If Case 1 applies, then take u(xy) to be larger than u(x,). If Case 2 applies. take ulxy) to he smaller than uly). Suppose now that Case 9 applies. Let I= i ¢ (lu... N- Ih x) > xy,)) and J= Ge ..., N= De Xyu1 > Xj Completeness and the assumption that there is no indifference implies that 1 u J = G,..., N- 1). The transitivity implies that both I and dare “intervals,” in the sense that if i ¢ I and {’ <1, then i’ € 1; and if j€Jand j’ > j, then j © J. Let i* = max I, then i* + 1 = min J. TakeUomy) 10 tie the open interval (ulxje,,).t(%j_))- Then it is easy to see that u(-) represents x on the whole X. ‘Suppose next that there may be indifference between some two elements of x). For each n = X= &, AN, define %,, = Og, © X q, ~ %,)- There by the reflexivity of ~ (Proposition LB.1GD), UN.X, = Xs Also, by the transitivity of ~ (Proposition 1.8.16i)), if X, # X,, then X, 0%, #8 So in Xe n° Xm let M be a subset of (1,...,N) such that X Umen%nn 290 X,, # X, for any me M ‘and any ne M with m#n, Define an relation »* on {X,,: m € M} by letting X,, Fe he lalla le tal indifference between two different elements of (X,,: me M). Thus, by the preceding result, there exists a utility function u®(+) that represents 2*. Then define us XR by ulx,) = uNX,) if me Mand x, € X,, It is easy to show that, by the transitivity, u(+) represents >. LCA If y € Cl(xy,2)), then the WA would imply that y « C((x,y)), Rut contradicts the equality Cl(x,y)) = Gd. Hence y € C({x,y,2)). Thus CUx,y,2)) € (20,(2),00,2)) 1.€.2 The property in the question are cyuivalent to the following proper") Wee, B eB, xeByeB, xeBy y eB, x € OB), and y © OB), then x € C(B’) and y € CIB). We shall thus prove the equivalence between this property and the’ Weak Axion. Suppose first that the Weak Axiom is satisfied. Assume that B ¢ 8, B’ ¢ B,x* y, then there is some B € B such that x € B, y € B, x € CIB), and y € G(B). Thus x >" y. Suppose that y »* x, then there 8 Re A such that xB, ye Band x © G(B). But the Weak Axiom impliee that y € C(B), which is a contradiction. Hence if x >* y, then we cannot have yy" x. Hence x >** y. Conversely, suppose that x >** y, then x x* y but not y >* x. Hence there is some B € B such that x ¢ B, y ¢ B, x C(B) and if x € BY and yc BY for any BY © B, then y € C(B"). In particular, x € C(B) and y € C(B). Thus xt y, The equality of the two relation is not guaranteed withont the WA. As can be seen from the above proof, the WA is not necessary to guarantee that if x >" y, then x >* y, But the converse need not be true, as shown by the following example. Define X = (x,y,z), B= ((x,y)(x,y,2)), Clix.) = (x), and C((x,y,z)) = {y). Then x >* y and y >* x. But neither x >* y nor y >* x, (b) The relation >* need not be transitive, as shown by the following example Detine X = (x,y.2h, B= (Oxy) (y.2)), Clay?) = tx) and Cl{y,2)) = ty). Then x >* y and y >* z. But we do not have x >* z (because neither of the two sets in B includes (x,z}) and hence we do not have x >* z either. (c) According to the proof of Proposition 1.D.2, if B includes all three element subset of X, then »* is transitive. By Proposition 1.B.1(i), »** istransitive. Since >* ts equal to >**, >* 1s also transitive. ‘An alternative proof is as follows: Let x ¢ K, y ¢ K, 2 € X, x ># y, and y >* z, Then {x.y.z) € B and, by (a). x >** y, and y >"* z, Hence we have neither y >* x nor z >* y. Since >* rationalizes (B,C(-)), this implies that y € CUix,y,2)) and z € Clix,y,2)). Since Cl{x,y.2)) # @, CUx,y.2)) = (x). Thus x >* 2. LD.1 The simplest example is X = (x,y), B= Ux){y)), CUO) = Ge, Cy) = (y). Then any rational preference relation of X rationalizes C{-). L.D.2_ By Exercise 1.B.5, let u(+) be a utility representation of . Since X its, for any BS X with B+ @ there exists x © B such that u(x) = u(y) for all y ¢B. Then x ¢ C*(B,>) and hence C¥(B,,) + 0. (A direct proof with no use of utility representation is possible, but it is essentially the same as the proof of Exercise 1.B.5.) 1.D.3 Suppose that the Weak Axiom holds. If x € G(X), then x © C(Xx,z)), which contradicts the equality Gl(s,z)) = {2}. If y € G(X), then y € CUix,y), which contradicts Cl(x,y)) = (x). If z € C(X), then z € Clty,z)), which contradicts C((x,z)) = (y}. Thus (B,C{-)) must violate the Weak Axiom, L.D.4 Let » rationalize G(-) relative to BR, Let x € G(H, W BL) and y © GCF) v GB), then x x y bevause By UB, > G(B,) v O(B,). Thus x © O(0(B,) uv ctp,)). Let x € O(C(B,) v O(B,)) and y € B, v Bp. then there are four cases: Case 1. x € CIB), y € By.Case 2. x © OB), y © By, Case 2 x 6 CB), ¥ ¢ BY. Case 4. x € CIB,). v € By. If either Case 1 or 4 is true, then x » y follows directly from rationalizability, If Case 2 is true, then pick any z € C(B,). Then z > y. Since x € O(C(B,) u CIB,)), x x z. Hence, by the transitivity, x > y. If Case 3 is true, then pick any z € C(B,) and do the same argument as for Case 2. 1.D.5 (a) Assign probability 1/6 to each of the six possible preferences, which are x > y>Z,X>Z>Y,Y>X>2¥>Z>x,Z>x>y, andzry> (b) If the given stochastic choice function were rationalizable, then the probability that at least one of x > y, y » z, and z » x holds would be at most 3 x (1/4) = 3/4. But, in fact, at least one of the three relations ~ always holds, because, if the first two do not hold, then y » x and 2 > y. Hence the transitivity implics the third. Thus, the given stochastic choice function is not rationalizahle (c) The same argument as in (b) can be used to show that a = 1/3. Since CUx,y = CUiy,2)) = CUZ,x}) = (a 1 - a) is equivalent to Cl{y,x)) = Czy = OKx.2n " (1 ~ @ a), if we apply the same argument as in (h) to y >) Z> y, and x > 2, then we can establish I - @ = 1/3, that is, « = 2/9, Thus, in order for the given stochastic choice function is rationalizable, it is necessary that a € [1/3,2/3]. Moreover, this condition is actually sufficient: For any « € [1/3,2/3], assign probability a - 1/3 to each of x > Meé y>2,y>Z>x, and z > x > y; assign probability 2/3 - @ to each of x > 2 > yy yx z, and z>y 7x. Then we obtain the given stochastic choice function. 17CHAPTER 2 2.D.1 Let p, be the price of the consumption good in period 2, measured in units of the consumption good in period 1. Let x,, x, be the consumption levels in periods 1 and 2, respectively. Then his lifetime Walrasian budget 2. < set is equal to (x € RU: x, + ppx, = wh. 2n2 (uh) eR: b= 24, pe ens 28 2.D.3 (a) No. In fact, the budget set consists of the two points, each of which is the intersection of the budget line and an axis. () Let xe By, XB, yy and A € [0,1]. Write x" = Ax +1 - alk’. Since X is convex, x" « X. Moreover, p-x" = Ap-x) + (1 = AVlp-x') = Aw + (1 = Adw =w. Thus x" B |. paw 2.D.4 It follows from a direct calculation that consumption level M can be attained by (6 + (M ~ 85)/s") hours of labor. It follows from the definition that (24,0) and (16 - (M - 86)/c’, M) are in the budget cet. But their convex combination of these two consumption vectors with ratio M - 8s is not in the budget set: the amount of leisure of this combination equals to 16 (so the labor is eight hours), but the amount of the consumption good is 8 8 8 M >M—Po—ae = Mae = 88 ve HSE vs Hee Ws 22.E.1 The homogeneity can be checked as follows op, ew xjlepew) = a : op, + ap, + OP AP) ap, aw Xglepew) = Gaps ay BPS 2 D7 Py Py Py ep, ow xglap.aw) “ap, + ap, + =, OP, To see if the demand function satisfies Walras’ law, note that PP, + Pz + Py pextow) = Pipaeuaes) Hence p:x(p,w) = w if and only if @ = 1. Therefore the demand function satisfies Walras' law if and only if & = 1 2.E.2 Multiply by p,/w both sides of (2.£.4), then we obtain L Lge! PpylP¥0/ WG pl.) 8p, P,/x (WI) + PLY (P.WI/W Hence p_by(p.wep(p.w) + by(p.w) = 0. By (2.E.6), TE _(ppeglp. w)/ wil x ylp.v)/8N(w/xy(p.¥)) Hence Lye ¢lP-Wlepy(P.w) = 1. 2.5.3. There are two ways to verify that p:D,x(p,wip = = w. One way {s to post-multiply (2.E.5) by p, then p-D.x(p.w) p+ w= 0 by Walrac’ law. The other way is to pre-multiply (2.F.1) by pT, then p-Dpx(p,wip + p+D, x(p,w)w = 0, By Proposition 2.E.3, this is equal to p-D,x(p,wp + w An interpretation is that, when all prices are doubled, in order for the consumer to stay at the same consumption, it is necessary to increase his wealth by w. 2-2 °.2.6.4 Dy differentiating the equation x(paw) = axtp,w) with respect to a and evaluating at a = 1, we obtain wD,,x(p,w) = x(p,w). Hence D,lp,w) ~ (/w)x(p.w). Hence €,,, = (8xylp.w)/ow)lw/x,(p.w)) = 1, This means that an one-percent increase in wealth will increase the consumption level for all guods by one percent. Since (1/w)x(p,w) = x(p,1) by the homogeneity assumption, D.,x(p,w) is a function of p only. The assumption also implies that the wealth expansion path, F, = Gx(pyw): w > 0}, is a ray going through x(p,). 2.E.S Since x(p,w) is homogeneous of degree one with respect to w, x(p,aw) = ex(p,w) for every a > 0. “Thus x,(p,w) = x,(p,lw. Since ax,{p,11/8p, = Spq(p)/op, = 0 whenever k + & xp(pd) is actually @ Function of pp alone, So we can write xy(pw) = x/(P_). Since x(p,w) is homogencous of degree zero, x,(Py) must be homogeneous of degree - 1 (in p,). Hence there exists a, > 0 such that x(pj) = ay/py, By Walras’ law, Typy(cty/p,Jw = wD ya, = w. We must thus have Syay = 1. 2.E.6 When @ = 1, Walras’ nw and homogeneity hold, Hence the conclusions of Propositions 2.E.1 ~ 2.E.3 hold. 2.6.7 By Walras’ law, (w - ppqi/n, = w/p, ~ (p)/p,)ew/p,) = UL - alw/p,. ‘2 2 This demand function is thus homogeneous of degree zero. 2-32.6.8 For the first part, note that In ¥((p.w) = In yylexptin p,),....exptin p, exp(in w)), Thus, by the chain rule, ax, ax, atin x,(0.00) apie re tin Pi apeh wd aE 7 pw = eyiprwT 7 See Similarly, ax, ax, (in xylp.w)) = (p.w)-explin w) ay iP wlw Sat BT pipe * Fel Since a, = d(in, x,(p,w))/dlln pj), a, = dlln x)(p,w))/alIn pp), and a, = (in x(p,#))/dlin w), the assertion is established 2.F.1 We proved in Exercise 1.C.2 that Definition 1.C.1 and the property in the exercise is equivalent. It is easy to see that the latter is equivalent to the following property: For every Be B and B' ¢ B, if O(D) nD’ ¥ © and D 1 C(B") @, then CIB) n BY c CIB") and Bn C(B') < CIB). If Cl-) is single-valued, then this property is equivalent to the following one: For every B ¢ B and B’ € B, if C(B) < BY and Bc C(B’), then C(B) = C(B"). In the context of Walrastan demand functions, this can be restated as follows: For any (p,w) and (p',w'), if p-x(p',w') = w and p’-x(p,w) = w’, then x(p,w) = x(p',w"). But this is the contraposition of the property stated in Definition 2.F.1. Hence Definitions 1.C.1 and 2.F.1 are equivalent, 2.F.2 It is straightforward to check that the Weak Axiom holds. In fact, if = 9. since p?x! = 8, x2 Js 8 andi + 4, then p’-x’ Is revealed P preferred to x!, similarly, siuce p!-x9 = 6, x! is revealed preferred to x%,But, since p°-x" = 8, x° is revealed preferred to x 2.F.9 [First printing errata: Add the sentence "Assume that the weak axiom is satisfied." in (b) and (c).] Denote the demand for good 2 in year 2 by y. (a) His behavior violates the weak axiom if 100-120 + 100y = 100-100 + 100-100 and 100-100 + 80-100 100-120 + Soy. That is, the Weak Axiom is violated if y ¢ [75,0]. (b) The bundle in year 1 is revealed preferred if 100-120 + 100y = 100-100 + 100-100 and 100-100 + 80-100 > 100-120 + 80y, that is, y < 75. (c) The bundle in year 2 is revealed preferred if 100-100 + 80-100 = 100-120 + 8oy ana 100-120 + 100y » 100-100 + 100-100, that is, y > 80. (@) For any value of y, we have suffictent information to Justity exactly one of (a), (b), and (c). (©) We shall prove that if y < 75, then good 1 is an inferior good. So suppose that y < 75. Then100-120 + 100y = 100-100 + 100-100 and 100-100 + 80-100 > 100-120 + Boy. Hence the real wealth decreases from year 1 to 2. Also the relative price of good | increases, But the demand for good 2, y, deercases because y < 75 < 100. This means that the wealth effect on good 1 must be negative. Hence it is an inferior good. (f) We shall prove that if 80 < y < 100, then good 2 is an inferior good. So suppose that 80 < y < 100. Then 100-100 + 80-100 = 100-120 + Soy 100-120 + 100y > 100-100 + 100-100. Hence the real wealth increases from year 1 to 2. Also the relative price of good 2 decreases. But the demand for good 2, y, decreases because y < 100. This means that the wealth effect on good 2 must be negative. Hence it is an interior good. 2A (a) IE Lg <1, then (py°%)/lpy'¥q) <1 and hence pox) 1, then (p,-x,1/(p,-%p) > 1 and hence Pyx, > Py'Xy- Thus the consumer has a revealed preference for x, Over Xo A. Hence, by taking 2 (©) If py = Ap, and w, = Aw), and x, = x5, then E, Q larger or smaller than one. we can make Eq larger or smaller than one. But this obviously does nol have any revealed preference relationship.2.F.5 We shall first prove the discrete version. By the homogeneity of degree one with respect to wealth, it is enough to show that (p’ ~ p)-Ge(p',1) - x(p,1)) 0 for every p and p’. Since = x(p) = Soe (et PtP = x(p.10) 1 + Ode, Seip) > x0, it is sufficient to show that (p’ - p)-(x(p',p'+x(p,1)) ~ x(p,1)) = 0, and . 1 < @ ~ Prete, Sze TT) > XIPID) = 0. For the firet inequality, note that (p’ = p)-Ge(p',p'+x(p,0) = x(p,1)) = - pexe(p’sp!-aelpt)) + 1 If x(p',p’+x(p,1)) = x(p,1), then the value is equal to zero. If 2(p',p'+x(p,1)) # 2x(p,1), then the weak axiom implies that p-x(p',p’+x(p,1)) > 1, Henee the above value is negative. ‘As for the second inequality, . . 1 (8 ~ PG, Sestpay) ~ tea) ero 1 = prextp) - ——t Pixle. Sepp) > Pl) - Soetegy tt = 2 (pexlpD + — 6D Boxe TT 52-2 Viploxtp. MM Srsteay) 2-2=0. The infinitesimal version goes as follows. By differentiating x(p,aw) = cx(p,w) with respect to a and evaluating at @ = 1, we obtain D..x(p,wiw = x(pyw). Hence 2-7 éSlp.w) = D,x(p,w) + D, xtpywhe(p,w)™ = Dx(p.w) + (1/wlx(pywhelp, 0)" thus Dyxtpaw) = Stpiw) - arm xtpwixtpiw) By Proposition 2.F.2, S(p,w) is negative semidefinite. Moreover, since vs Gelp,whetp,w) Ww =~ (vexe(p,w))*, the matrix - (1/wix(p.whx(p,w)! is also negative semidefinite. Thus D,x(p,w) is negative semidefinite. 2.F.6 Clearly the weak axiom implics that there exists w > 0 such that for every p, p’, and w’, if p-x(p',w") = w and x(p',w') # x(p,w), then p'-x(p,w) > Conversely. suppose that such a w > 0 exists and that p:x(p’,w") = w and x(ptw!) # x(p,w). Let & = w'/w. Then x(p',w') = x(p',ew) = x(a /p',w) by the homogeneity assumption, and p-xta"'p',w) = w and x(a'p',w) # x(p,w). But this implies that (a!p')-x(p,w) > w, or, equivalently, p'-x(p,w) > aw = w'. ‘Thue the weak axiom holds. 2.F.7 By Propositions 2.E.2 and 2.E.3, P-Sip.w) = p-D,x(p.w) * p-D,x(piw)x(pw)" = peDyxlpw) + x(pw)" = 0 By Proposition 2.F.1 and Walras’ law, Ty - Sip.wip = Dyx(p.w)p + D,,x(p.wix(p.w)'p = Dpx(p.w)p + Dyx(p.w)w = 0. 2, pce 2F8 Sq(Pow) = Sopa tah) Piece Ppaeese=r - (pw) + aan (we, (pw) Ep) Op, ¥lewT Bw x ax, PX, (Pw) = ey (Pw) + We et pw) KE ePr xlp.w) ow EydP.W) + Cp (Pr¥ID, (PW)2.F.9 (a) Since x"ATx = (x"Ax)" = xTAx, a matrix A is negative definite if and gnly if xT AK + xTalx <0 for every x € K\(U). Since xtax 4 xTATs = xT(A + AT)x, this is cquivalent to the negative definiteness of A+ AT. Thus A is negative definite if and only if so is A + al ‘The case of negative definiteness can be proved similarly. ‘The following examples shows that the determinant condition is not sient fr the nsec cse. tat A= [4 2, J then Ay = 1 : - “1 and Ayy = 1 But, [4% I[ i ] = 1. Hence A is not negative semidefinite. (®) Let S(p,w) be a substitution matrix. By Proposition 2.F.3, S(p,wip = 0 and hence syo(p,w) = (- Py/pa)ay,(p.¥)- Also p-S{p,w) = 0 and hence 55,(p,¥) = p,/pQ)5,,(P.w). Thus s,(p,w) = (pt/ps)s,,(p.v). Thus, for every v = H v5)" © Now, suppose that S(p,w) ic negative semidefinite ond of rank one. According a 2 2 ,.2),2 VeSEp.We = 5, (P,WILVT = (2Py/PQ),¥> + (BI/PEIND) < = e 2. = 54 (P.wI(¥, > (Y7P2V5) to (*), the negative semidefiniteness implies that <,,(p,w) = 0. Reing of rank one implies that 5,,(p,w) * 0. Hence s,(p,w) < 0. Thus s,p{p.w) < 0. Conversely, let s,,(p,w) < 0, then, by (*), v-S(p,wlv < 0 for every v. 2.F.10 (a) If p = (1,11) and w = 1, then, by a straightforward calculation, we obtain 2-9Hence Sipiw) is not symmetric. Note that =r (pL o =a Shy) * 2 sar - 3V574. 7. =- - Bagi Be 6, 7 ‘Theorem M.D.4(iii), S(p,w) 1s negative semidefinite. (v) Let p= (tj) and w = 1. Let Sip,w) be the 2 x 2 cubmatrix: of Sip,w) obtained by deleting the last row and column. By a straightforward calculation, we obtain ° = 3e Spam = @ + e*[ 25 ® eral Thus, 7 7 1 2, 4, 4, ostam] 4 | =a, tel 1] = e+ ere ater > 0. ° if © > 0 is sufficiently small. Then Stp,w) is not negative semidefinite and hence the demand function in Exercise 2.E.1 does not satisfy the Weak Axiom. 2.F.IL By Proposition 2.F.3, Sip,w)p = 0 and hence s,,(p.w) = (- py/pp)sylp,w). Also p-S(p,w) = 0 and hence sp,(p,w) = (- p,/P9}54,(P.¥)- (We saw this in the answer for Exercise 2.F.9 as well.) Thus s,.(P,w) Spy(PW) 2.F.12 By applying Proposition 1.D.1 to the Walrasian choice structure. we know that x(p,w) satisfies the weak axiom In the sense of Definition 1.C.1. By Exercise 2.F.1, this implies that x(p,w) satisfies the weak axiom in the sense of Definition 2.F.1.2.F.13 [First printing errata: In the last part of condition (*) of (b), the inequality p-x > w chould be p'-x > w’. Also, in the last part of (c), the ~ relation x’ € x(p.w) should be x’ ¢ ¥(p,w). (a) We say that a Walrasian demand correspondence satisfies the weak axiom if the following condition ic satiefied: For any (p,w) and (p’,w'), if x € 2(b.w), x © x(p'yw'), pix = w', and p>x’ = w, then x" € x(p,w). OF equivalently, for any (p,w) and (p',w"), if x € x(pyw), x’ © alps), pox’ = w, and x’ € x(p,w), then psx > w! (b) If x © x(p,w), x’ € x(p',w’), and p-x’ < w, then x’ € x(p,w) by Walras’ law. ‘Thus p'-x > w'. (©) If x € x(p,w), x’ € x{p'w'), and p'sx = w', then (p! = p)-(x’ = x) = w= p-x'. If, furthermore, x’ « x(p,w), then Walras’ law implies that px’ = w. Hence (p' - p)-(x’ - x) = 0, If, on the contrary. x’ € x(p.w), then the generalized weak axiom implies that p-x' > w. Hence (p' ~ p)-(x' - x) <0. « (@) It can be shown in the same way as in the small-type discussion of the pranf af Proposition 2.F.1 that, in order to verify the assertion, it is sufficient to show that the generalized weak axiom holds for all compensated price changes. So suppose that x € x(p,w), x’ ¢ x(p'.w"), p'-x = w', and p+x’ Sw. Then (p' - p):(x' - x) = w - p-x' = 0. Hence, by the generalized compensated law of Demand, we must have (p' ~ p):(x' = x) = 0 and x’ € x(p,w). 2.F.14 Let p >> 0, w > 0, and @> 0, Since p-x(p,w) = w and (ap)-x(ap,aw) = aw, we have ap-x(p.w) = aw and p-x(ap,aw) = w. The weak axiom now impl au &that x(p,w) = x(ap,aw), 2.F.1S Since ax,(p,w)/ew = 0 for both £ = 1,2, we have sp(p,w) = ax(p,w)/0p, for both & = 1,2 and k = 1,2. Hence, let Stp,w) be the 2 x 2 submatria of Slp.w) obtained by deleting the last row and column, then S(p,w) = [ool 2} ri mate te seative seit tense wy, a ‘ “1 - Pau -ee- Wy, - r2Lo -1 4 ly te 7 %2 (We saw this iu the answer to Exercise 2.F.10(a).) Hence, by Theorem cee] 72) - av5/4. M.D.4liii), v-S(p,w)v <0 for alll v not proportional to p. Since Sip,w) is not symmetric, Sip.w) is not symmetric either. 2.F.16 (a) The homogeneity can be checked as follows: X,lop,aw) = apap, = Pp/Py = X{(P.W)s x,lap.aw) = ~ apy/ap, = - By/P3 ~ Xp(Pw) x,lap.aw) = aw/ap, = W/py = x3(P,W). As for Walras’ law, P,x,lb.09 + Poxplp.w) + PaXa(P.W) = (PP. ~ PyPy + PaW)/Py = W- (b) Let p = (2,0, w = 1, p’ = (11), and w’ = 2, then x(p.w) = (2, 1, 1) and x(p'w') = (1, - 1, 2). Thus p'+x(pyw) = 2 = w! and p-x(p!,w') = 1 = w. Hence the Weak Axiom is violated. (©) Denote by Dx(p,w) the 2 x 2 submatrix of the Jacobian matrix Dx(p,w) obtained by deleting the last row and column, then oe sat vii.w = ange! 4] Let Sip.w) be the 2 x 2 submatrix of S(p,w) obtained by deleting the last row 2-12and column, then S(p,w) = Dx(p,w) = wel aa ] because ax,(p,w)/aw = éxpip,wi/ow = 0. Note that v-Sipwiv = 0 for every ¥ € R°. Now let ve R 3 Note that v = (v - (vg/P3)P) + (v3/P5)P and the third coordinate of v - (vg/Pq)P is equal to zero. So denote its first two coordinates by v € R°, ‘Then, by Proposition 2.F.3, v-S(p.wiv = ¥-S(p,wiv = 0. 2.F.17 (a) Yes. In fact, xylapow) = aw/Zyap,) = w/SyPy) = x,(p.w) () Yes, In fact, p-x(p.w) = Dex (p.w) = Dppw/(Spp)) = w. (©) Suppose that p’-x(p,w) = w’ and p-x(p',w') $ w. The first inequality implies that (Eypj)w/(Eyp)) + w', that is, w/(fyp,) 3 w'/(Dypp)- The second inequality implies similarly that (J,p))w'/(Syp)) = w, that is, w'/(Sypi) = WAQypy). Therefore w/(Eyp)) = w'/(Sypj). Hence x{p,w) = xfp',w'). Thus the weak axiom holds. % (@) By calculation, we obtain eee 2, Dyelp,w) = (= w/Typg))} : ala ieee) D, (Pw) = (W/T,p,) = x(p.w). Hence Sip,w) It is symmetric, negative semidefinite, but not negative definite, 23 &CHAPTER 3 3.B.1 (a) Assume that » is strongly monotone and x >> y. Then x ® y and x # y. Hence x > y. Thus > is monotone. (b) Assume that x is monotone, x € X, and © > 0. Let e = (1,..41) € RU and y= x+(cMD)e. Then ly ~ xls © and y » x. Thus » is locally nonsatiated. 3.B.2 Suppose that x >> y. Define € = Min Gx = Yyy oir my ~ yp) > ©, then, for every 2 € X, if ly - zl < e, then x >> z, By the local nonsatiation, there exists z* ¢ X such that lly - z*ll < © and z* > y. By x >> 2* and the weak monotonicity, x > 2*. By Proposition 1.B.1(iii) (which is implied by the transitivity), x > y. Thus > is monotone r ) 3.B.3 Following is an example of a convex, locally nonsatiated preference relation that Ie not monotone in 2. For example, # >> y but J > 0 x3.C.1 Let » be a lexicographic ordering. To prove the completeness, suppose ‘that we do not have x > y. ‘Then "y, > x," : 7 Hence and “x, # y, or yp > x," EAL and ¥9 > x, either *y, 7 x)" oF Thus y x x. To prove the transitivity, cuppose that x > y and y x 2. Then x, > yy and y, = 2. Hence x, & 7). If x, > 2), then x xz. If x, = 2), then x, = ¥, = 2, Thus x, = yp and yp =z. Hence x, = zp, Thus x > 2. To show that the strong monotonicity, suppose that x = y and y # x. This , or that x, = y, and x, > yp. In implies either that x, > y, and x, > y, 7 either case x > y. To show the strict convexity, suppose that y > x, 2> x, y #2, and ae (0.1). Without loss of generality. assume that x # y. By the definition of the lexicographic ordering, we have either "y, > x," or "y, = x, and y, > x)". On the other hand, since z » x, we have either "z, > x," or "2, = x, and x, = Cv Jor” Hence, we have either “ay, + (1 - wz, 7 x," oF “ayy + (L~ az = xy and ayy + (1 - az, > xy." Thus ay + (1 - az > x. 3.C.2 Take a sequence of pairs (x) y"))"_, such that x" > y" for all n, x" + x, and y® + y, Then u(x") © uly") for all n, and the continuity of ul-) implies that u(x) = u(y). Hence x » y. Thus x is continuous. 3.€.2 One way to prave the assertion is to assume that > is monotone and notice that the proof actually make use only of the closedness of upper and lower contour sets. Then the proposition is applicable to x, implying that it has a continuous utility function. ‘Ihus, by Exercise 3.C.2, » 1s continuous. A more direct proof (without assuming monotonicity or using a utility function) gocs as follows. Suppose that there exist two sequences (x"} and 32fy") in X such that x" > y" for every n, x" > x €X, y" > ye X, and y> x. Since (2: ¥ > 2} is open, there exists a positive integer N, such that y > x” for every n> Ny. Since (2: 2 > x) is open there exists a positive integer N, such that y" > x for every n> Ny. Conceivably, there are two cases un the Ly: sequence (y"): Case 1: There exists a positive integer N such that y" » y for every n > N, Case 2: There exists a subsequence (y“) such that y > y* for every n. If Case 1 applies, then, by Propusitivi 1.B.1(iii), we have y" > x” for every n> Max (N.N3). This is a contradiction. If Case 2 applies, then there exists a positive integer m such that k(m) > Ny Since {z: z > yet), is oven, there exists postive Integer Ny such that gP > 8) top every > Ngo By x® k(n) ly xy" and Proposition 1.8.11), x > y em) for every n> Ny. Since (2: z x y""™) is closed, x x ¥ But, since k(m) > Np, this is a contradiction. .C.4 We provide two examples. The first one ie cimpler, but the second one satisfies monotonicity, which the first does not. Example 1. Let X- R, and define u(+): R, > R by letting u(x) = 0 for * <1, u(x) = 1 for x > 4, and uli) be any number in [0,1]. Denote by » the preference relation represented by u(-). We shall now prove that x is not continuous, In fact, if u(1) > 0, then consider a sequence (x) with x = 1 ~ Wn for every n, Although x" ~ 0 for every n and x" 9 1, we have 1 > 0. If u(1) <1, then consider a a sequence {x"} with x” = 1 + 1/n for every n. Although x" ~ 2 for every n and x" 4 1, we have 2 > 1. Note that if u(x) = 0, then all lower contour sets are closed. If u(1) = 1, then all upper contour sets are closed. 3-3Example 2, Take X ~ R2 and define a utility function u(-): RZ > R by the following rule: Case 1. If x +% = 2 and x # (1,1), then u(x) = Xt XD Case 2. If mintx,, oh = 1 and x # (1,0), then ulx) = min{x,,X,) +2. Case a. If x, + x, > 2, mints, x,) <1, and x, > X,, then u(x) = 3 - O - On, - 0). Case 6 + x, > 2, minty, x) <1, and x, < x5, then u(x) = 3 - (1 - xx, - 2. Case 5. u(i,1) € [2,3]. ‘The indifference curves of the preference relation » represented by u(-) are desi ‘bed in the following picture: cy 2 1 == oo 0 1 2 x Figure 3.0.4 It follows from this construction that u(-) is continuous at every x # (1,1). ‘The preference » is convex and monotone. But, whatever the choice of the value of u(l,1) is, it cannot be continuous at (1.1). In fact, (= 1/a, 1 - 1/n) > G1) and (+ 1a, 1+ W/m) > (0) as n> @, and u(l = a, 1 /n) = 2 - 2/0 9 2 3-4ull + In 1+ Yn) = 1+ in +293. Henes, if 2 < ullsl)s then (2,0) x 1. ~ W/m, d= a/m) but (141) » (2,015 If ul) <3, then (1 + In, 1+ 1/n) » (2,1) but (21) > G41). If uC = 3, ‘then all upper contour sets of » are closed: if u(l,1) = 2, then all lower contour sets of » are closed. 3.C.5 (a) Suppose first that u(+) is homogeneous of degree one and let « = 0, xen, yent, and x~y. Then ulx) = uly) and hence au(x) = auly). By the homogeneity, ulax) = ulay). Thus ax ~ ay. Suppose conversely that » is homothetic. We shall prove that the utility function constructed in the proof of Proposition 3.C.1 is homogeneous of degree one. Let x € Ry and «> 0, then ulxle ~ x and ulaxle ~ ax. Since » is homothetic, au(x)e ~ ax. By the transitivity of ~ (Proposition 1.B.1(ii)), ulcxrde ~ cu(xde. Thus u(exx) = aulx). (b) Suppose first that x is represented by a utility function of the form u(x) 4 OOK). Leta eR xe RE, ye RY, and x ~ y, Then ulx) = uly) and hence u(x) + @ = uly) + a. By the functional form, Ua) + 6 = (@ + Hy) + Hayy a) = ulx + ae), uly) +e = (@ +) + BID) = OLY + 20), where € = (1,0.....0) € RE. Hence u(x + ae,) = uly + ae,). or x + ae, ~ ¥ + ae, ‘Suppose conversely that > is quasilinear with respect to the first commodity. The idea of the proof of this direction is the same as in (a) or Proposition 3.6.1, in that we reduce comparison of cammadity bundles on a Tine by fining out indifferent bundles and then assigning utility levels along the line, But this proof turns out to exhibit more intricacies, partly because it 35depends crucially on the connectedness of RL”), which appears in X = (- @, @) xR} (Connectedness was mentioned in the first simall-lype discussion i the proof of Proposition 3.C.1.) The proof will be done in a series of steps, First, we show that comparison of bundles can be reduced to a line parallel to ej. Then we show that the quasilinearity of » implies the given functional form. Let x be a quasilinear preference and a utility function u(-) represent x. ‘The existence of such a (+) is guaranteed by Proposition 3.C.1, but, of course, it need not be of the quasilinear form. For each x € RL, define 1G) = (uGc8) © RE x, © R), then 1G) is a nonempty open interval, by the continuity and the strong monotonicity of 7 along ey, Step i For every xe RU andj € RE", if 16K) # 169), then 18) 9 1G) 2 Proof: Suppose that IG) # (7). Without loss of generality, we can assume that there exists u € I(x) such that u ¢ Ily]. Then either u = sup G7) or u + infl(G). Suppose that u = euplly). (The other case can be treated similarly.) Then let xf € R satisfy u = Glxt.x), then, for every y, € R. Ge.) > (y9). In particular, for every x, © Rand yy © Ry Gtk) > (y, - +24, 9). By the quasilinearity, this implies that (x,,%) > yD. Thus GO.8) > G9). Hence 1G0 0 19) = &. For each x € RE, define E(x) = Je RE! 1) = 1G))- Step 2: For every x € RL, EGX) is open in RL Proof: Let Ke RL, x, €R, and u = lx, x) € IG), Let © > 0 satisty (u- ec, u +e) ¢ 1G). Since ii{+) is continuous, there exists 5 > 0 such that it Fe WL and ux ~ yu <6, ten 1dlxx) ~ Glxy) < ©. Hence 3-61G) AI > G@- eure alee L-1, Thus, by Step 1, 16) =). or Fe EG. tence G eRe! ak - ju <8) ¢ E(x). Thus E(x) is open. Step 3: For every xe RE, BG ~ a, Proo; It is sufficient to show that for every xe RL and ye RE, we nave FU) = EG). Suppose net, then there exit Se RET and 3 RET auch that Elo) # E(y), then the complement RL“\E(x) is nonempty. By Step 1, RENEGH) is equal to the union of those E(3) for which ye RL NEG:. By Step 2, this implies that RL“\E(E) is open. Hence we have obtained a pertition (EGO,RE NEGO) of RL, both of whose elements are nonempty aud ‘open. This contradicts the connectedness of RL! Hence Else) = Ely) for every xe RL and jy RE By Step 3, I(x) = 1(0) for every xe RL! Thus for every xe RU, there exists a unique @ € ® such that oe, ~ (0.3). Detine ¢: wl (0,n) for every x € RL. Define us X > R Uy ula) = x, + Kye: 3K by alte, ~ ‘for every x eX Step 4: The function u(-) represents x. Proof: Suppose that x ¢ X, y € X, and x > y. By the quasilinearity, this is equivalent to (x, - Ys Xpyeees Xp) X (O,Yyyeeu¥,)- By the definition of 66), Chis ix equivalent 0 (x) = yy) Xp xp) 5 O09 yp Je Again by Je, Again ets r (Oxo XL) x Qa) + ¥, — Hey Again by the definition of ¢(+), this is equivalent to OK yooor MIO_ 2 HY gH -orVE) + Hy ~ MDOy- Hence PX p.04 Xp) = Oy ed_) + Yy ~ Xp that is, ulX) = UG. 3-7‘These properties of u(-) are cardinal, because they are not preserved under some monotone transformation, such ax Flu(a) = ufal? 3.6.6 (a) For p = 1, we have u(x) = a,x, + a,x,. Thus the indifference curves are linear. (b) Since every monotonic transformations of a utility function represents the same preference, we shall consider toa = - (a,x? + aagx?) Gx) = Inulee) = (17plin(eryxf) + a.yx8). By L’Hopital’s rule, lim U0) xd = lim (a, +a, ax + a Hin ting, + aime vin + 08) = (ayInx, + a,Inx,)/(a, + a). is Seen! . Since expl(a, + @,Vilse)) = x,'x,°, we have obtained a Cobb-Douglas utility function There is an alternative proof to this proposition: Since both the CES and the Cobb-Douglas utility functions are continuously differentiable and homothetic, it is sufficient to check the convergence of the marginal rate of substitution at every point. The marginal rate of substitution at (x,,x)) with respect to the CES utility function is equal to @,xf/a,x5"'. The marginal rate of substitution at (x,,x,) with respect to the Cobb-Douglas uullity function is equal to a,x,/a%,, Note that «x2 "'a,x2" » a,x,/2% as p>. (in tact, «x "lagx8°l ts well defined for every p and is equal 0 @,x,/a,x, when p= 1.) The proof is thus completed. Strictly speaking, there is a missing point in both proofs: We proved the convergence of preferences on the strictly positive orthant (x € R: x >> 0),