Midterm

Problem 1. One-consumer, one-producer economy. The economy consists of a

firm that transfers labor into a final consumption good, and a consumer who values both
leisure and the consumption good. The total endowment of the consumer’s labor is L = 1.
Assume that the consumer receives all the profits of the firm.
p
The firm’s production technology is f (z) = A z for some A > 0. The consumer’s utility
is u(x1 , x2 ) where x1 denotes the amount of leisure and x2 denotes the amount of the final
consumption good. Normalize the wage rate as 1 and denote by p the price of the final good.

1. Derive the consumer’s and the firm’s first-order conditions.

2. Suppose that the utility function is u(x1 , x2 ) = ln x1 + ln x2 . Derive the competitive

equilibrium price and output of the final consumption good. How do these vary with
A and ?

3. Suppose that the utility function is u(x1 , x2 ) = x1 + ln x2 . Derive the competitive

equilibrium price and output of the final consumption good. How do these vary with
A and ?

Problem 2. One-consumer, two-producer economy. Suppose there are two output

goods (x1 and x2 ) and two factors (K and L). Firms’ production technology are

f1 (K1 , L1 ) = (K1 )1/2 + (L1 )1/2 and f2 (K2 , L2 ) = (K2 )1/2 + (L2 )1/2

The consumer owns the production factors and his total endowment is (K, L). The consumer
have no taste for the consumption of factors of production, and his utility depends only on
the consumption of the two output goods and is given by

u(x1 , x2 ) = ln x1 + ln x2

where x1 is his consumption of output good 1 and x2 is his consumption of output 2. Assume
that the consumer receives all the profits of the two firms.

1. Derive the production possibility frontier.

2. Derive the equilibrium factor allocation ((K1⇤ , L⇤1 ), (K2⇤ , L⇤2 )) and the equilibrium factor
prices (r⇤ , w⇤ ) and the equilibrium output prices (p⇤1 , p⇤2 ). (Normalize p⇤1 = 1 first.)

3. Formulate and solve the social planner’s problem.

1
 Problem 3. Shapley-Folkman-Starr. Let X be a set of four points on the plain:
X = {(0, 0), (0, 1), (1, 0), (1, 1)}.

1. What is CH(X) (convex hull of X)? What is the inner radius of X (Hint: it is not 1
p p
or 2 or 2/2)?

2. Plot X + X and CH(X + X). Is it equal to CH(X) + CH(X)? What is the inner
radius of CH(X + X)?

3. Let X2i = {(0, 0), (0, 1), (1, 0), (1, 1)} and X2i 1 = {(0, 0), (0, 2), (2, 0), (2, 2)} for i =
P P2n
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be represented as

2n
X
x= xi
i=1

where no more than 2 of the xi in the sum need to be taken from their respective
CH(Xi ); at least 2n 2 can come from the original (nonconvex) Xi . Furthermore,
P
provide an upper bound for the inner radius of 2n
i=1 CH(Xi ) by applying Shapley-
Folkman-Starr?

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 Problem 3. Shapley-Folkman-Starr. Let X be a set of four points on the plain:
X = {(0, 0), (0, 1), (1, 0), (1, 1)}.

1. What is CH(X) (convex hull of X)? What is the inner radius of X (Hint: it is not 1
p p
or 2 or 2/2)?

2. Plot X + X and CH(X + X). Is it equal to CH(X) + CH(X)? What is the inner
radius of CH(X + X)?

3. Let X2i = {(0, 0), (0, 1), (1, 0), (1, 1)} and X2i 1 = {(0, 0), (0, 2), (2, 0), (2, 2)} for i =
P P2n
1, 2, . . . , n where n > 1. What is 2n i=1 CH(Xi )? Show that any x 2 i=1 CH(Xi ) can
be represented as

2n
X
x= xi
i=1

where no more than 2 of the xi in the sum need to be taken from their respective
CH(Xi ); at least 2n 2 can come from the original (nonconvex) Xi . Furthermore,
P
provide an upper bound for the inner radius of 2n
i=1 CH(Xi ) by applying Shapley-
Folkman-Starr?

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