Microeconomics II - LMEC - a.y.

2021/2022
Problem set 1

Instructions
• Hand out date: November 18, 2021.
• Hand in date: November 29, 2021, by midnight.
• Hand in form: upload the answer file (preferably in pdf format) in the feeds avail-
able in the e-learning website.
• Format: typed solutions are appreciated (LaTeX is the way to go, ShareLaTeX and
Overleaf are efficient ways to work jointly on your problem set). Keep the answer
sheet within a few pages (3 to 6 pages should be enough).
• Groups: you may hand in individually or in groups of at most 4 students. Indicate
in the answer file name, surname and matriculation number of all group members.
• Grading: this problem set determines 15% of the final grade. It will be graded, on a
0-32 scale, according to the following criteria:
– Timeliness: you receive the full grade if you hand in on time, you lose 1/3 of
the grade for each day of delay, and there is no evaluation for a delay of 3 or
more days;
– Completeness, accuracy and correctness: for each of problems 1 and 2, and for
each letter of problems 3 and 4, the completeness, accuracy and correctness of
your answer is evaluated with up to 1.5 points, 1.5 points and 1 point, respec-
tively.

Problem 1 Suppose a preference relation % on Rn+ is represented by a utility function

u : Rn+ → R. Prove that % is convex if and only if u is quasi-concave.
Answer.
(⇒) Suppose % is convex. Fix any x ∈ Rn+ . By convexity we know that when-
ever y % x and z % x, we have αy + (1 − α)z % x for any α ∈ [0, 1]. Con-
sider the set {t ∈ Rn+ |u(t) ≥ u( x )}. Let y, z ∈ {t ∈ Rn+ |u(t) ≥ u( x )}. Then,
since u(·) represents % and αy + (1 − α)z % x we have u(αy + (1 − α)z) ≥ u( x ),
that is, αy + (1 − α)z ∈ {t ∈ Rn+ |u(t) ≥ u( x )} for any α ∈ [0, 1]. Thus, the set
{t ∈ Rn+ |u(t) ≥ u( x )} is convex, establishing the quasi concavity of u(·).

(⇐) Suppose u(·) is quasi concave. Then, the set {t ∈ Rn+ |u(t) ≥ u( x )} is convex.
Suppose that y % x and z % x. Then, since u(·) represents %, we have u(y) ≥ u( x )
and u(z) ≥ u( x ). Thus, y, z ∈ {t ∈ Rn+ |u(t) ≥ u( x )}. By convexity of the set {t ∈
Rn+ |u(t) ≥ u( x )} we get, for any α ∈ [0, 1], αy + (1 − α)z ∈ {t ∈ Rn+ |u(t) ≥ u( x )},
that is, u(αy + (1 − α)z) ≥ u( x ). Thus we have αy + (1 − α)z % x which establishes
that % is convex.
Problem 2 Provide an example of a preference relation that is not continuous but can be
represented by a utility function.
Answer.
Let X = R+ and let u(·) : R+ → R be defined by u( x ) = 0 for x < 1, u( x ) = 1
for x > 1 and u(1) = 1/2. Let % be represented by u(·). We show that % is not
continuous. Consider the sequence xn = 1 + n1 and yn = 1 − n1 , where xn  yn for
all n, and xn → x = 1 and yn → y = 1, yet we dont have x  y since 1 ∼ 1. Thus,
continuity is violated.

Problem 3 Suppose X = R2+ and ( x1 , x2 ) % (y1 , y2 ) when x1 > y1 , or x1 = y1 and

x2 ≥ y2 . Defend your answer to the following questions.
a. Is this preference relation rational?
b. Is it continuous?
Answer.
This is an example of lexicographic preferences where good 1 is the dominant good.
Lexicographic preferences are complete and transitive but not continuous.

Completeness: Consider any two points in R2+ : x = ( x1 , x2 ) and y = (y1 , y2 ). If

x1 > y1 , x % y. If y1 > x1 , y % x. If x1 = y1 , it must be that either x2 ≥ y2 in which
case x % y, or y2 > x2 in which case y % x.

Transitivity: Let x, y, z ∈ R2+ where x = ( x1 , x2 ), y = (y1 , y2 ) and z = (z1 , z2 ).

Suppose x % y and y % z. Then x1 ≥ z1 . There are two cases. If x1 = z1 , then
x1 = y1 = z1 , in which case it must be that x2 ≥ y2 ≥ z2 and thus x2 ≥ z2 , which
means that x % z. If x1 > z1 , then we immediately know x % z.

Continuity: Consider two converging sequences, { xn } and {yn }, such that ∀n,

xn ∈ R2+ and lim xn = x

n→∞

yn ∈ R2+ and lim yn = y

n→∞

and xn  yn , ∀n. If % were continuous, we would have x % y. Here is one coun-

terexample. Let xn = (1/n, 0) and yn = (0, 1). Then x = (0, 0) and y = (0, 1), xn 
yn ∀n, but y  x. So lexicographic preferences are complete and transitive but they
violate continuity.

Problem 4 An individual consumes two goods and her utility function is:

u ( x1 , x2 ) = [min (2x1 + x2 , x1 + 2x2 )]2

a. Draw some indifference curves.
b. Is the utility function: (i) concave, (ii) quasiconcave, (iii) homogeneous, (iv) ho-
mothetic?
c. Find the Walrasian demand for both goods.
d. Find the indirect utility function.

Answer.
a. The indifference curves will be the same as those of min (2x1 + x2 , x1 + 2x2 ). The
first argument of the min is smaller when

2x1 + x2 < x1 + 2x2 ⇒ x1 < x2

Lets find the indifference curve for the utility level ū2 . If x1 < x2 then ū = 2x1 +
x2 ⇒ x2 = ū − 2x1 , with a slope of 2. If x1 > x2 then ū = x1 + 2x2 ⇒ x2 =
ū/2 − x1 /2, with a slope of 1/2. Therefore, the indifference curves look like this:

b. concave: Consider the utility level along the 45-degree line, that is, u( x, x ) as x
increases. It is equal to 9x2 , which is not concave. Therefore, this utility function is
not concave.

quasiconcave: As we can see from the indifference curves, the upper level sets are
convex. Therefore u(.) is quasiconcave.

homogeneous:

u(tx1 , tx2 ) = [min (2tx1 + tx2 , tx1 + 2tx2 )]2

= [t min (2x1 + x2 , x1 + 2x2 )]2

= t2 [min (2x1 + x2 , x1 + 2x2 )]2
Therefore, it is homogeneous of degree 2.

homothetic: A homothetic function can be formulated as an increasing transforma-

tion of a function that is homogeneous of degree 1. u( x1 , x2 ) = f ( g( x1 , x2 )) where
f ( x ) = x2 and g( x1 , x2 ) = min (2x1 + x2 , x1 + 2x2 ) is homogeneous of degree 1.
Therefore, it is homothetic.

c. Suppose income is y and prices of x1 , x2 are p1 , p2 . The optimal bundle will be the
p
point(s) where the indifference curves are tangent to the budget line with slope − p21

p1 y
• p2 > 2 the upper left corner is optimal x∗ = (0, p2 )
p1
• p2 = 2 all points on the upper half of the indifference curve are optimal: x∗ =
{t(0, py2 ) + (1 − t)( p1 +y p2 , p1 +y p2 )|t ∈ [0, 1]}
p1 y y
• 2> p2 > 1
2 the mid point is optimal x∗ = ( p1 + p2 , p1 + p2 )
p1
• p2 = 12 all points on the lower half of the indifference curve are optimal: x∗ =
{t( py1 , 0) + (1 − t)( p1 +y p2 , p1 +y p2 )|t ∈ [0, 1]}
p1 y
• p2 < 1
2 the lower right corner is optimal x∗ = ( p1 , 0)

d. Indirect utilities are given by:

 2
p1 y
• p2 ≥ 2, v( p1 , p2 , y) = p2
 2
p 3y
• 2 > p12 > 21 , v( p1 , p2 , y) = p1 + p2
 2
p1 1 y
• p2 ≤ 2 , v ( p 1 , p 2 , y ) = p1