751701 Microeconomic Theory A Master of Economics, CMSE

Exercise 2: Topic in Consumer Behavior

Answer all following questions

1. Construct an indirect utility function that corresponds to the direct function
U = a ln q1 + q2. Use Roy’s identity to construct demand functions for the two goods.
Are these the same as the demand functions derived from the direct utility function?
2. A consumer who obeys the von Neumann-Morgenstern axioms and has an initial wealth
of 500,000 is subject to an accident. There is a 15 percent probability of a major accident
with a loss of 40,000 and a 10 percent probability of a disastrous accident with a loss
of 150,000. Her utility function is U=W0.5.
2.1 What is the maximum premium that she is willing to pay?
2.2 If she is offered an insurance policy with the deductibility provision that she bear
the first 5000 of any loss. What is the maximum premium that she is willing to pay
for this policy?

Exercise 3: The Theory of the Firm

Answer all following questions

1. Assume that an entrepreneur’s short-run total cost function is
C = q 3 - 10q 2 + 17q + 66 . Determine the output level at which he maximizes profit if
p=5. Compute the output elasticity of cost at this output.
2. Suppose a firm’s production function 𝑞 = 𝑥! 𝑥" , solve for the conditional demand
for inputs x1 and x2. Solve for the cost-minimized function. If q = 100, r1 = 1, and r2 = 4,
find x1 and x2. and firm’s cost.
3. Suppose a firm’s production function 𝑞 = 𝑥! 𝑥" , solve for the input demand for
inputs x1 and x2 that firm maximizes profit. If P = 10, r1 = 1, and r2 = 4, find x1 and x2.
and firm’s profit.