Addis Ababa University

College of Business and Economics

Department of Economics

Econ 601: Advanced Microeconomics I

2022/23, semester I
Assignment #1, due 10 January 2023

Directions
1. All answers should be complete
2. Show the main steps of your answers
3. Answers should be submitted in type or in legible handwriting
4. You can submit the assignment in groups of up to five students
5. In case of group work, make sure every member takes part in solving all questions

1. Suppose an individual obtains utility from consumption of x and y according to the

following Stone-Geary utility function: (page 158, Micholson and Synder)
U(x,y) = (x-x0)ayb,
where a+b=1; x0 is minimum food to keep him alive and y represents other goods. Let px and
py denote unit prices of x and y, respectively and m represent his income.
a) Show that if m>pxx0, the individual will maximize utility by spending a(m-pxx0)+ pxx0 on
good x and b(m- pxx0) on good y, where m is his income.
b) Suppose px=10, py=1, x0=4 units, and a=b=0.5.
i. How much of x and y is consumed if m=40?
ii. How much of x and y is consumed if m=100?
2. Consider a consumer who derives utility from consumption of x1 and x2 according to
1 1
u( x 1 , x 2 =x 12
) x 22
The consumer faces prices p1=1 and p2=1 for x1 and x2, respectively, and has income m=100
a. What are the optimal consumptions of x1 and x2?
b. Suppose p1 increases to 2, p1 =2
i. Calculate the new optimal consumptions of x1 and x2
ii. Calculate the income and substitution effects.
3. Mamo's monthly income is $1000. He currently spends 40% of his income on food and the
rest on luxuries. If his income increases by. $200, how much will he spend on food given that
his income elasticity of food is 2?
4. A consumer consumes goods x and y and has the indirect utility function given by

( )
3 /2
m 1
v ( p , m)=2
3 p x p1y/2 ,
Where px and py are prices of x and y, respectively and m is his monthly income.
 a) Derive his Marshalian demand and expenditure functions. What are the expenditure shares
of the two goods?
b) Suppose government encourages low income consumers by covering half the price of
good x and this consumer is covered by this program. What is the impact of this price
support on utility and how much does it costthe government if initially px=10, py=5 and
m=9000?
c) Now suppose that government gives this consumer a lump sum amount of 6000 per
month.
i. What is the impact of this program on the welfare of the consumer?
ii. Compare the welfare impacts of the two programs. Which one is better and why?
5. Consider the following profit function that has been obtained from a technology that uses a
single input: π(p,w)= p2wa, where p is the output price, w is the input price and a is a
parameter value.
a. Show that the profit function is non-decreasing in output price.
b. Derive the supply function of the product and the input demand function.
6. Kebede produces chairs, using as inputs labor (L) and machines (K). His production function
is given by the following equation:
2/3 1/2
q = 10K +L
a. What type of returns to scale (increasing/constant/decreasing) does Kebede’s production
function exhibit?
b. At the end of last year, Kebede bought his only machine for $1,000. He will use this
machine for 5 years, after which the machine will have no value. Kebede will calculate
depreciation linearly (depreciation will be 20% of the total value of the machine per year).
This machine has no other use besides Kebede’s production of chairs, and, at this moment,
Kebede cannot buy any more machines. What is Kebede’s annual fixed cost of production?
Is the fixed cost sunk or not? Explain.
7. Abebe’s company produces knee warmers according to the following production function:

a. Assuming that the unit cost of capital (r) and the unit wage (w) are both equal to 1, derive
Abebe’s demand for inputs—capital and labor, respectively—as a function of his choice of
output (q).
2
b. Show that Abebe’s long run total cost function is given by C(q) = 8+2q .
8. Consider a firm with the following profit function:
1

p(p,w) =p(y(p,w))-wx(p,w) =
w ( )( )
1−a w
a ap
a−1

a. Find the input demand and output supply functions for the firm.
b. Show that it is homogeneous of degree 1 in (p,w).