Econ 415/615 Mathematics for Economists Lau

Problem Set XII Fall 2021

Comparative Statics
1) Consider the following leisure/labor choice problem
max U (C , l )
C ,l

s.t. w(T − l ) + N = C where C : consumption

l : leisure
w : wage rate
T : total time available
N : non − labor income
a) Set up the Lagrangian of this problem.

Assume the second order condition is fulfilled.

C * l *
b) Determine the signs of and .
N N
Now suppose the utility function is additively separable so that U (C , L) = U 1 (C ) + U 2 (l ) and
U 1 '(C )  0, U 1 "(C )  0, U 2 '(l )  0, and U 2 "(l )  0 .
C * l *
c) Determine the signs of and .
N N
Now suppose the utility function is U (C , l ) = Cl .
C * l *
d) Determine the signs of and .
N N

2) SF Corporation produces output X according to the production function X = f ( K , L) where K

denotes capital and L denotes labor. If the Corporation purchases K units of capital and does
not hire an "expert" to explain the operation of the capital, then "a" units of capital are wasted
and the effective capital available is ( K − a ) units. If the Corporation hires an expert of type
"y" ( 0  y  1 ), then if K units of capital is purchased, the effective capital will be ( K − ay )
units. However the Corporation must pay the expert C ( y ) for his service. Since a type y '
expert is more helpful than a type y " expert if and only if y '  y " (so that fewer units of
capital are wasted), we assume C ( y )  0, C '( y )  0 and C "( y )  0 .
f KK f KL
Also assume f KK , f LL  0 and 0.
f LK f LL
Let SF Corporation be a profit-maximizing firm.
a) Formulate the profit-maximizing problem.
b) What are the choice variables in the problem?
c) What are the parameters in the problem?
d) Determine the optimal value of the choice variables you suggested in part b).
e) What will happen to the optimal value of the choice variables you suggested in part b)
when the price of capital increases? When the price of labor increases?

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3) Consider the following utility maximization problem:
U *  max U ( X + F , Y )
X ,Y

s.t. M = PX X + PY Y
where F is the amount of "free" Xs provided by the government

Assume the second order condition is fulfilled.

X * Y * U *
a) Determine the signs of , , and .
F F F
b) Now suppose the utility function is additively separable so that
U ( X , Y ) = U 1 ( X ) + U 2 (Y ) and U 1 '( X )  0,U 1 "( X )  0,U 2 '(Y )  0, and U 2 "(Y )  0 .
X * Y *
Determine the signs of , and .
F F
[Be sure to mention the Implicit Function Theorem.]

4) Consider the following expenditure-minimizing problem:

e*  min PX X + ( PY + t )Y where t is the sales tax per unit
X ,Y

s.t. U ( X , Y ) = U
Assume the second order condition for a minimum is fulfilled.
X * Y *
Determine the sign of , and .
t t

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Econ 415/615 Mathematics for Economists Lau
Problem Set XII: Solution
1a) L = U (C , l ) + [ w(T − l ) + N − C ]
choice variables: C, l, 
parameters: w, T , N

b) FONC:
L
= U C (C , l ) −  = 0 (1)
C
L
= U l (C , l ) −  w = 0 (2)
l
L
= w(T − l ) + N − C = 0 (3)


SOSC:
L LC Ll 0 −1 −w
LC LCC LCl = −1 U CC U Cl  0 (assume the condition is satisfied)
Ll LlC Lll −w U lC U ll

The Jacobian of the system is the matrix in the SOC, since it is  0 , by the Implicit Function
Theorem, from (1)–(3), we can write C* = C ( w, T , N ), l* = l ( w, T , N ) and * =  ( w, T , N ) .

Substitute these into the FOCs, we have

w[T − l *( w, T , N )) + N − C *( w, T , N )  0 (4)
U C [C *( w, T , N ), l *( w, T , N )] −  *( w, T , N )  0 (5)
U l [C *( w, T , N ), l *( w, T , N )] − w *( w, T , N )  0 (6)

Differentiate (4)–(6) with respect to N , we have

l * C *   * 
−w +1− =0  
N N  0 −1 − w   N   −1
C * l *  * C *   
U CC + U Cl − = 0   −1 U CC U Cl   = 0
N N N  −w U 
 N   
 U ll   
l *   
0
C * l *  * lC

U lC + U ll −w =0  
N N N  N 

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 0 −1 − w
−1 0 U Cl
C * −w 0 U ll wU Cl − U ll
 = = = ? (since we don't know U Cl )
N 0 −1 − w (+)
−1 U CC U Cl
−w U lC U ll
0 −1 −1
−1 U CC 0
l * −w U lC 0 U − wU CC
= = lC = ? (since we don't know U lC )
N 0 −1 − w (+)
−1 U CC U Cl
−w U lC U ll

c) Now suppose the utility function is additively separable so that U (C , L) = U 1 (C ) + U 2 (l ) and

U 1 '(C )  0, U 1 "(C )  0, U 2 '(l )  0, and U 2 "(l )  0  U Cl = U lC = 0
C * wU Cl − U ll −U ll
 = = 0
N (+) (+)
l * U lC − wU CC − wU CC
= = 0
N (+) (+)

d) Now suppose the utility function is U (C , l ) = Cl so that

U C = l , U Cl = 1, U CC =0, U l = C , U ll = 0 and U lC = 1 .

C * wU Cl − U ll w  1 − 0
 = = = w  0 (N  C*  )
N (+) (+)
l * U lC − wU CC 1 − wU CC 1
= = =  0 ( N  l* )
N (+) (+) (+)

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2a) max  = p f ( K − ay, L) − wL − rK − c( y ) where c '  0, c "  0
K , L, y

b)c) choice variables: K , L, y

parameters: p, a, w, r

d)e) FONC:

= pf K ( K − ay, L) − r = 0 (1)
K

= pf L ( K − ay, L) − w = 0 (2)
L

= pf K ( K − ay, L)(−a) − c '( y ) = −apf K ( K − ay, L) − c '( y ) = 0 (3)
y

SOSC:
 KK  KL  Ky pf KK pf KL −apf KK
 LK  LL  Ly = pf LK pf LL − apf LK  0 (assume the condition is satisfied)
 yK  yL  yy − apf KK − apf KL a pf KK − c "
2

The Jacobian of the system is the matrix in the SOSC, since it is  0 , by the Implicit Function
Theorem, from (1)–(3), we can write K * = K ( p, a, w, r ), L* = L( p, a, w, r ) and y* = y ( p, a, w, r ) .

Substitute these into the FOCs, we have

pf K [ K *( p, a, w, r ) − ay *( p, a, w, r ), L *( p, a, w, r )] − r  0 (4)
pf L [ K *( p, a, w, r ) − ay *( p, a, w, r ), L *( p, a, w, r )] − w  0 (5)
−apf K [ K *( p, a, w, r ) − ay *( p, a, w, r ), L *( p, a, w, r )] − c '[ y *( p, a, w, r )]  0 (6)

Differentiate with respect to r , we have

K * y * L *  K * 
pf KK ( −a ) + pf KL −1 = 0  
r r r  pf KK pf KL −apf KK   r   1 
K * y * L *   L *   
pf LK ( −a ) + pf LL =0   pf LK pf LL −apf LK   = 0
r r r  r   
 −apf −apf KL a pf KK − c "  
2
  0 
K * y * L * y *  KK
y *
−apf KK ( −a ) − apf KL − c" =0  
r r r r  r 

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 1 pf KL −apf KK
0 pf LL −apf LK
K * 0 −apf KL a pf KK − c "
2
pf LL (a 2 pf KK − c ") − a 2 p 2 f KL f LK
 = =
r pf KK pf KL −apf KK ( −)
pf LK pf LL −apf LK
−apf KK −apf KL a 2 pf KK − c "
a 2 p 2 ( f KK f LL − f KL f LK ) − pf LL c "
= 0 since f KK f LL − f KL f LK  0 (SOSC)
( −)
pf KK 1 −apf KK
pf LK 0 −apf LK
L * −apf KK 0 a pf KK − c "
2
a 2 p 2 f KK f LK − pf LK (a 2 pf KK − c ") c " pf LK
= = = =?
r pf KK pf KL −apf KK ( −) ( −)
pf LK pf LL −apf LK
−apf KK −apf KL a pf KK − c "
2

pf KK pf KL 1
pf LK pf LL 0
y * −apf KK −apf KL 0 − ap 2 f LK f LK + ap 2 f KK f LL ap 2 ( f KK f LL − f KL f LL )
= = = 0
r pf KK pf KL −apf KK ( −) ( −)
pf LK pf LL −apf LK
−apf KK −apf KL a pf KK − c "
2

When r  , the company will want a better expert, i.e. a smaller y .

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Differentiate with respect to w , we have
K * y * L *  K * 
pf KK ( −a ) + pf KL =0  
w w w  pf KK pf KL −apf KK   r   0 
K * y * L *   L *   
pf LK ( −a ) + pf LL −1 = 0   pf LK pf LL −apf LK   = 1
w w w  r   
 −apf −apf KL a pf KK − c "  
2
  0 
K * y * L * y *  KK
y *
−apf KK ( −a ) − apf KL − c" =0  
w w w w  r 
0 pf KL −apf KK
1 pf LL −apf LK
K * 0 −apf KL a pf KK − c "
2
a 2 p 2 f KK f KL − pf KL (a 2 pf KK − c ") pf KL c "
 = = = =?
w pf KK pf KL −apf KK ( −) ( −)
pf LK pf LL −apf LK
−apf KK −apf KL a pf KK − c "
2

pf KK 0 −apf KK
pf LK 1 −apf LK
L * −apf KK 0 a pf KK − c "
2
pf KK (a 2 pf KK − c ") − a 2 p 2 f KK
2
−c " pf KK
= = = 0
w pf KK pf KL −apf KK ( −) ( −)
pf LK pf LL −apf LK
−apf KK −apf KL a 2 pf KK − c "
pf KK pf KL 0
pf LK pf LL 1
y * −apf KK −apf KL 0 −ap 2 f KK f KL + ap 2 f KK f KL
= = =0
w pf KK pf KL −apf KK ( −)
pf LK pf LL −apf LK
−apf KK −apf KL a pf KK − c "
2

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3a) L = U ( X + F , Y ) +  (M − PX X − PY Y )
Choice Variable: X , Y, 
Parameters: PX , PY , M , F

FONC:
L = M − PX X − PY Y = 0
LX = U X ( X + F , Y ) −  PX = 0
LY = UY ( X + F , Y ) −  PY = 0

SOSC:
L L X LY 0 − PX − PY
LX  LXX LXY = − PX U XX U XY  0 (assume the condition is satisfied)
LY  LYX LYY − PY UYX UYY

The Jacobian of the system is the matrix in the SOSC, since it is  0 , by the Implicit Function
Theorem, from (1)–(3), we can write X * = X ( PX , PY , M , F ), Y * = Y ( PX , PY , M , F )
and * =  ( PX , PY , M , F ) .

Put these back into the FONCs,

M − PX X * ( PX , PY , M , F ) − PY Y * ( PX , PY , M , F )  0
U X [ X * ( PX , PY , M , F ) + F , Y * ( PX , PY , M , F )] − PX  * ( PX , PY , M , F )  0
UY [ X * ( PX , PY , M , F ) + F , Y * ( PX , PY , M , F )] − PY  * ( PX , PY , M , F )  0

Differentiate with respect to F , we have

X * Y *   * 
− PX − PY =0  
F F  0 − PX − PY   F   0 
X * Y *  *  X *  
U XX ( + 1) + U XY − PX = 0   − PX U XX U XY   = −U

F F F  F   XX 
 −P UYY     −UYX 
X * Y *  *  Y U YX
Y * 
UYX ( + 1) + U YY − PY =0  
F F F  F 

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 0 0 − PY
− PX −U XX U XY
X * − PY −U YX U YY − P P U + PY2U XX
 = = X Y YX =?
F 0 − PX − PY (+)
− PX U XX U XY
− PY U YX U YY
0 − PX 0
− PX U XX −U XX
Y * − PY U YX −U YX − P P U + PX2U YX
= = X Y XX =?
F 0 − PX − PY (+)
− PX U XX U XY
− PY U YX U YY
U * ( X * + F )
Also by Envelop Theorem, we have = U X ( X * + F , Y *) = U X ( X * + F , Y *)  0
F F

b) If U ( X , Y ) = U 1 ( X ) + U 2 (Y ) and U 1 '  0, U 1 "  0, U 2 '  0, and U 2 "  0 ,

then U XY = UYX = 0 .
X * − PX PY U YX + PY2U XX PY2U XX
 = = 0
F (+ ) (+ )
Y * − PX PY U XX
= 0
F (+)

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4a) L = PX X + ( PY + t )Y + [U − U ( X , Y )]

Choice Variable: X ,Y , 
Parameters: PX , PY , t , U

FONC:
L = U − U ( X , Y ) = 0 (1)
LX = PX − U X ( X , Y ) = 0 (2)
LY = ( PY + t ) − U Y ( X , Y ) = 0 (3)

SOSC:
L L X LY 0 −U X −UY
LX  LXX LXY = −U X −U XX −U XY  0 (assume the condition is satisfied)
LY  LYX LYY −UY −UYX −UYY

The Jacobian of the system is the matrix in the SOSC, since it is  0 , by the Implicit Function
Theorem, from (1)–(3), we can write X * = X ( PX , PY , t , U ), Y * = Y ( PX , PY , t , U ),
and * =  ( PX , PY , t ,U ) .

Put these back into the FONCs,

U − U [ X * ( PX , PY , t , U ), Y * ( PX , PY , t , U )]  0
PX −  * ( PX , PY , t ,U )U X [ X * ( PX , PY , t , U ), Y * ( PX , PY , t , U )]  0
PY + t −  * ( PX , PY , t ,U )U Y [ X * ( PX , PY , t , U ), Y * ( PX , PY , t , U )]  0

Differentiate with respect to t , we have

X * Y *   * 
−U X − UY =0  
t t  0 −U X −UY   t   0 
X * Y *  *  X *   
− *[U XX + U XY ] −UX = 0   −U X −U XX −U XY   = 0
t t t  t   
 −U 
−U YX −U YY     −1
X * Y *  *  Y Y *
1 −  *[UYX + U YY ] − UY =0  
t t t  t 
0 0 −UY 0 −U X 0
−U X 0 −U XY −U X −U XX 0
X * −UY −1 −UYY −U X U Y Y * −U Y −U YX −1 U X2
 = = 0 = = 0
t 0 −U X −U Y ( −) t 0 −U X −U Y ( −)
−U X −U XX −U XY −U X −U XX −U XY
−UY −U YX −U YY −U Y −U YX −U YY

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