ECON6067 Computation and Analysis of Economic Data

Problem Set 2
Karen Xiaoting Mai

1. The present value of a continous cash flow at the constant rate of M for n years, discounted
´n
as the rate of r can be written as 0 M e−rt dt. Calculate the definite integral.
ˆ n
n
−rt M −rt  M −nt
M
1 − e−nt


Me dt = − e  = − e −1 =
0 r 0 r r

2. Use the Lagrangian-multiplier method to find the stationary values of f (x1, x2 ) = x1 − 3x2 −
x1 x2 , such that x1 + x2 = 3.
Lagrangian
L = x1 − 3x2 − x1 x2 + λ (3 − x1 − x2 )

FOC

∂L
= 1 − x∗2 − λ∗ = 0
∂x1
∂L
= −3 − x∗1 − λ∗ = 0
∂x2
∂L
= 3 − x∗1 − x∗2 = 0
∂λ

Therefore x1 ∗ = − 12 , x2 ∗ = 27 , λ∗ = − 52 , f (x1 ∗, x2 ∗) = − 37
4
.

3. We mentioned that instead of g (x1 , x2 ) = c, the constraint can be written as g (x1 , x2 ) =

0. How should the Lagrangian and the first-order conditions be modified in the following
example we saw in class? f (x1 , x2 ) = x21 + x22 , such that 2x1 + x2 = 4.
The constraint can be written as 2x1 + x2 − 4 = 0. Lagrangian

L = x21 + x22 + λ (0 − (−4) − 2x1 − x2 )

1
 remains essentially the same. So FOCs remain the same.

4. Prove that cov (a + bX + cV, Y ) = bσXY + cσV Y .

cov (a + bX + cV, Y ) = E {[(a + bX + cV ) − (a + bµX + cµV )] (Y − µY )}

= E {[b (X − µX ) + c (V − µV )] (Y − µY )}
= E [b (X − µX ) (Y − µY ) + c (V − µV ) (Y − µY )]
= bE [(X − µX ) (Y − µY )] + cE [(V − µV ) (Y − µY )]
= bσXY + cσV Y

5. Suppose Y is normally distributed with mean µ and variance σ 2 . Express Pr(a ≤ Y ≤ b) in

terms of the cummulative distribution function of standard normal distribution, Φ (·).
Since Y σ−µ follows standard normal distribution
 
a−µ Y −µ b−µ
Pr(a ≤ Y ≤ b) = Pr ≤ ≤
σ σ σ
   
b−µ a−µ
= Φ −Φ
σ σ