Practice Questions Micro Theory 1

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1. Suppose a firm’s production function is given by 𝒚 = 𝐦𝐢𝐧⁡(𝟐 𝒛𝟏 , 𝟒𝒛𝟐 ) and input prices are given
by 𝒘𝟏 = 𝟐⁡𝒂𝒏𝒅⁡𝒘𝟐 = 𝟒⁡
a. Find conditional input demand function 𝑧1 (𝑤1 , 𝑤2 , 𝑦)⁡and 𝑧2 (𝑤1 , 𝑤2 , 𝑦)! (5 points)
b. Find the cost function C(𝑤1 , 𝑤2 , 𝑦) and draw the average cost and marginal cost! (5 points)

2. A firm of Air Isi Ulang has the following production technology/function where Z 1 is the water and Z2 is the
capital of exploring water:

q = Z1/a+bZ2

where Z1 is the input of good-1, Z2 is the input of good-2, w1 and w2 are the input price of

good-1and good-2 respectively.

a. Find the input demand function! (6 point)

b. Find the supply function! (6 point)
c. Find the profit function! (6 point)
d. If the input price of good-1 is 4 and the input price of good-2 is 2, the price of output is 4,
a=b=2 then calculate the value of each question! (6 point).

3. Consider a competitive industry composed of J identical firms. Firms produce output

according to the Cobb-Douglas technology, q = xα k1−α, where x is some variable input such as
labour, k is some input such as plant size, which is fixed in the short run, and 0 < α < 1. At
prices p, wx, and wk, maximum profits are:
1 𝛼 𝛼
𝜋 𝑗 = 𝑝1−𝛼 ⁡𝑤𝑥𝛼−1 ⁡𝛼 1−𝛼 ⁡⁡(1 − 𝛼)𝑘 − 𝑤𝑘 𝑘
⁡⁡And individual firm’s supply is given by
𝛼 𝛼 𝛼
𝑞 𝑗 = 𝑝1−𝛼 ⁡𝑤𝑥𝛼−1 ⁡𝛼 1−𝛼 ⁡𝑘

If α = 1/2, wx = 9, and wk = 2, then supposing each firm operates at a fixed plant of

size k = 2 in the short run, find:
a. Individual firm supply 𝒒𝒋 ⁡𝑎𝑛𝑑⁡market supply 𝒒𝒔 ⁡𝑖𝑓⁡𝑡ℎ𝑒𝑟𝑒⁡𝑎𝑟𝑒⁡20⁡𝑓𝑖𝑟𝑚𝑠⁡𝑖𝑛⁡𝑡ℎ𝑒⁡𝑚𝑎𝑟𝑘𝑒𝑡! (7
points)
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b. If market demand is 𝑞𝑑 = 30 − 9 𝑝 find price and quantity market equilibrium!(3 points)
c. How much each firm supply to the market and how much is their profit/loss? (7 points)
d. What will happen in the long run? How much profit will each firm makes? (6 points)
 1 1 1 1
𝑚 𝑚
4. Suppose 𝑢(𝑥1 , 𝑥2 ) = 𝑥14 𝑥22 and indirect utility function is 𝑣(𝑚, 𝑝1, 𝑝2) = √23 ⁡(𝑝1)4 (𝑝2)2 and
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4 1 2
3
expenditure function is 𝑒(𝑢, 𝑝1, 𝑝2) = ⁡ 2 𝑢 𝑝1 𝑝2 . Also, 𝑝1 = 4, 𝑝2 = 4, 𝑚 = 300. A
3 3 3
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government project in infrastructure brings down the price of good one 𝑝1⁡𝑡𝑜⁡2⁡(𝑝1 = 2).

a. Find utility before the price change 𝑣(𝑚, 𝑝10 , 𝑝2)!

b. Find utility after the price change 𝑣(𝑚, 𝑝11 , 𝑝2)!

c. Find expenditure after the utility change and price change 𝑒(𝑢1 , 𝑝11 , 𝑝2)!

d. Find expenditure after price change keeping the utility constant 𝑒(𝑢0 , 𝑝11 , 𝑝2)!

e. Find the amount citizen willing to pay for the price change 𝐶𝑉 = 𝑒(𝑢1 , 𝑝11 , 𝑝2) −
𝑒(𝑢0 , 𝑝11 , 𝑝2)

f. Alternatively find Hicksian demand 𝑥1 (𝑢0 , 𝑝1, 𝑝2)⁡and re-estimate CV!

g. Using Marshallian demand find CS!

5. Consider a pure-exchange, private-ownership economy, consisting in two consumers, denoted

by i = 1, 2, who trade two commodities, denoted by 𝑥 𝑎𝑛𝑑⁡𝑦 . Individual utility functions are:
𝑢(𝑥1, 𝑦1 ) = 𝑥1𝑦1⁡𝑎𝑛𝑑
𝑢(𝑥2 , 𝑦2 ) = 𝑥2 + 𝑦2
Initial endowments are given by 𝜔1 = (4,2)⁡𝑎𝑛𝑑⁡𝜔2 = (2,3)
a. Draw and label the Edgeworth Box (draw the length of the Edgeworth box and indicate
the endowment point ω)! (7 points)
b. Draw the indifference curves of person1 and person2 in the Edgeworth box and indicate
the contract curve! (6 points)
c. Show the area in the Edgeworth box where both persons will benefit from trade
compared to if they consume at endowment point! (7 points)