 Exercise 2:

u1=x 1 +2 √ y 1 , ω1=5

u2=x 2 + √ y 2 ,ω 2=10
∂ u1
=M U x =1
∂ x1 1

∂u 1 1
=M U y = 0.5
∂ y1 y1 1

∂ u2
=M U x =1
∂ x2 2

∂u 2 1 1
=M U y =
∂ y2 2 y 0.5
2
2

1 0.5
MR S = y 1
2 0.5
MR S =2 y 2
y1
MR S1=MR S 2 → y 0.5 0.5
1 =2 y 2 → =4
y2

From the constraint we obtain y 1=10− y 2 and the contract curve

y 1=4 y 2 → 10− y 2=4 y2 → y2 =2

Calculating the allocation, we can set the Lagrange problem for good 2
L=2 √ y 1+ √ y 2 + λ ( 10− y 1− y 2 )

∂L 1 1
→ 0.5 =λ → y 1= 2 → y 1=t
∂ y1 y1 λ
∂L 1 1 t
→ 0.5 =λ → y 2= 2 → y 2=
∂ y2 2 y1 4λ 4

1
Setting the 2
=t
λ
t 5t
t+ =10 → =10→ t=8
4 4
y 1=8∧ y 2=2
o2
The contract curve is simply a horizontal line at 2 y =2 (or alternatively y 1=8 ¿ . There
could exist a Pareto optimal allocation at x 1=0 , x 2=5 , y1 =8 , y 2=2
 p1
Assuming ω 1=( 5,0 )∧ω2=( 0,10 ) and also ω '1=( 2,2 )∧ω '2=( 3,8 ) and that ≡p
p2
p1
MR S1= y 0.5
1 = → y 1 =p 2
p2

2 0.5 p1 p
2
MR S =2 y 2 = → y 2=
p2 4
2
I 1 → p x 1 + y 1=5 p → p x1 + p =5 p → x 1=5− p

If we have the case of 1) p1 >5 p 2 or p1=5 p2, then we have a corner solution and x 1=0 ,
thus the y 1=5 p. However if in case 2) p1 <5 p 2, then we have an interior solution with
y 1= p2 and x 1=5− p
2
' 2 2 2 p+2− p
I 1 → p x 1 + y 1=2 p+ 2→ p x 1 + p =2 p+2 → p x1 =2 p+2−p → x 1=
p
If we have the case of 1) p ≥1+ √ 3 (since price cannot be negative) then we have a
corner solution and x 1=0 , thus the y 1=5 p. However if in case 2) 0 ≤ p <1+ √3 , then we
2
2 p+2−p
have an interior solution with y 1= p2 and x 1=
p
In the problem the allocation does not depend on the initial endowment and if we have
8
an interior solution, we obtain same equilibrium with x 1= , x 2=5− √ 8 , y 1=8 , y 2=2
√8