ADDIS ABABA UNIVERSITY

FACULTY OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS
December 7, 2022
Econ 901: Advanced and Contemporary Topics in Microeconomics I
Semester I of the 2022/22 AY
Assignment 2
Instructor: Tekie Alemu

Attempt all questions and hand in your answers at the beginning of the class on
January 10, 2023. Not submitting your assignment will automatically result on zero
points allotted for this assignment.

1. Identify an example with consumer preferences that is unlikely to satisfy the assumption
of convexity.
2. Draw indifference sets that are straight, parallel, and negatively sloped, with preference
increasing northeasterly. Such preferences satisfy completeness, transitivity, continuity and
monotonicity. Prove that they also satisfy convexity but not strict convexity..
3. Suppose 𝑢(𝑥1 , 𝑥2 ) and 𝑣(𝑥1 , 𝑥2 ) are utility functions. Prove that if 𝑢(𝑥1 , 𝑥2 ) and 𝑣(𝑥1 , 𝑥2 )
are both homogeneous of degree r, then 𝑠(𝑥1 , 𝑥2 ) ≡ 𝑢(𝑥1 , 𝑥2 ) + 𝑣(𝑥1 , 𝑥2 ) is homogeneous of
degree r.
4. The consumer sets out to the market with w amount of currency, to purchase three goods
(x1, x1, x3) at the prevailing prices p1, p2, p3. He decided to spend all his w on these goods.
His utility function is of the following form:
𝑎 𝑎 𝑎
𝑢(𝑥1 , 𝑥2 , 𝑥3 ) = 𝑥1 1 𝑥2 2 𝑥3 3
a) What restrictions do we need to put on this function to be homogeneous of degree one.
b) Verify that once this condition is met, the utility function represents preferences that are
strictly monotonic and strictly convex.
c) Show that the elasticity of substitution for this utility function is constant.
d) Describe the consumer’s problem of finding a non-negative consumption bundle (x1, x2)
that is prepared to spend the whole amount of money (w) on these two goods.
e) Solve his problem:
f) Obtain the indirect utility function
g) Show that the indirect utility function is increasing in w and decreasing in prices.
h) Show that the indirect utility function is homogeneous of degree zero in (p, w) and that it
satisfies Roy's identity.
i) Obtain the expenditure minimization of this problem and derive the Hicksian demand
functions for the two goods

1
5. A CES utility function is given as follows:
1
𝜌 𝜌
𝑢(𝑥1 , 𝑥2 ) = (𝑥1 + 𝑥2 )𝜌
a) Verify that this utility function represents preferences that are strictly monotonic and
strictly convex.
b) Show that the elasticity of substitution for this utility function is constant.
c) Describe the consumer’s problem of finding a non-negative consumption bundle (x1, x2)
that is prepared to spend the whole amount of money (w) on these two goods.
d) Solve his problem:
𝜌
e) Let the parameter 𝜌−1 = 𝑟 to simplify the Walrasian demand functions and obtain the
indirect utility function
f) Show that the indirect utility function is increasing in w and decreasing in prices.
g) Show that the indirect utility function is homogeneous of degree zero in (p, w) and that it
satisfies Roy's identity.
h) Obtain the expenditure minimization of this problem and derive the Hicksian demand
functions for the two goods