Advanced Microeconomics 1 (Part 1) Prof. Dr.

Alfons Weichenrieder
Mid-term Exam Chair of Public Finance
Date: 1 December 2015
Approved implements: pocket-calculator

The exam is designed for 60 minutes. It consists of 4 problems. You are supposed to give an
answer to all of them. There is a maximum of 60 points to obtain. Good luck!

PROBLEM 1 (WALRASIAN DEMAND, 15 POINTS)

Consider the following Walrasian demand in a two-good economy:
xk ( p, w)  w /( p1  p2 ), k  1,2 .
(i) Is this demand homogenous of degree zero? (5p)
(ii) Does it satisfy Walras' law? (5p)
(iii) Compute the Slutsky matrix for this demand function and report the
compensated elasticity of substitution
[( H1 / H 2 ) / ( p1 / p2 )]  [( p1 / p2 ) /( H1 / H 2 )] . (5p)
PROBLEM 2 (EXPECTED UTILITY THEORY, 15 POINTS)
a) Consider the following lotteries.
 0.5 0.5   0.4 0.2 0.4   0.2 0.8   0.16 0.2 0.64 
L1   , L2   , L3   , L4   
100 1000  100 500 1000   0 2000   0 500 2000 

Does the preference ordering L1  L3 , L4  L2 satisfy the independence axiom? Explain

your answer. (10p)
b) Give an example for a utility function that implies constant relative risk aversion and
derive the Arrow-Pratt measure of relative risk aversion for this function. (5p)

PROBLEM 3 (PRODUCTION, 10 POINTS)

Production y takes places using labor (A) and capital (K). Factor prices for labor and capital
are denoted by w and r. The cost function is known as c(y, r, w) = 2 ⋅ 𝑦 ⋅ √𝑟𝑤. Is this cost
function associated with a quasi-linear, Leontieff, Cobb-Douglas production function, or
none of these? (10p)
PROBLEM 4 (CONSUMER THEORY, 20 POINTS)
a) Please draw an example of indifference sets (indifference curves) for a strictly convex,
locally nonsatiated preference relation that is not monotone. (5p)
b) Provide the definition of a quasiconcave function. (5p)
c) Provide the definition of convex preferences. (5p)
d) Does a strictly quasiconcave utility function imply strictly convex preferences and vice
versa? Give a sketch of your proof. (5p)