Assignment 1:Econ*6000 Fall 2011

Rubayyat Hashmi
0773365 Dept. of F.A.R.E, University of Guelph

October 11th, 2011
Problem 1. Read the Following article: “On the Futility of Criticizing the Neoclassical Maximization Hypothesis”, by Larry Boland, American Economic Review, Vol 71, December 1981, pages 1031-1036. (a) Summarize the arguments in this paper in no more that one page.(typed) (b) Do you agree or disagree with the author?Justify your answer (typed) Answer 1. (a) Many like Harvey Leibenstein, Nobel laureate Herbert Simon, and George Shackle argued against the maximization hypothesis .Some anti-neoclassical economist were encouraged by their argument. But the author Lawrence Boland of this paper argued that why, although the neo classical hypothesis is not a tautology, no criticism of that hypothesis will ever be successful. The authors arguments were based on firstly, the possible types of theoretical criticism and the logic of those criticism and secondly the methodological status of the maximization hypothesis in neo classical hypothesis. There are two types of criticism of maximization hypothesis.1) one can argue against the possibility of the hypothesized behavior (concerning necessary conditions of maximization behavior) 2) one can argue against the empirical truth of the premise of the hypothesis (concerning sufficient conditions of maximization behavior). For example, if the consumer is a utility maximizer, then for the particular bundle chosen, (a) the marginal utility is zero (b) the slope of the marginal utility curve at the point representing the chosen bundle is non-positive and usually negative. Either form (a) or (b) is the necessary conditions for maximization. Maximization premise is the sufficient condition for (a) and (b). Can necessary conditions be fulfilled? Here what is criticized is the possibility of fulfilling all of the necessary conditions for maximization. Are there more conditions than (a) or (b) listed above? Shackle, Hayek and Keynes argued about the behavioral hypothesis that maximization presumes knowledge necessary for choosing the best bundle has been acquired. Since all information is needed to calculate maximization, shackle argued it’s almost impossible. The author argues that inductive proof of knowledge is not necessary and true knowledge is not necessary for successful decision making. So, maximization behavior cannot be ruled out as a logical impossibility. Empirical Critique: Simon and Leibenstein, while accepting the logical validity of the hypothesis reject the idea of truth of the premise. Consumers are not necessarily maximizers , hence their behavior would not be determinable on that basis. The author argued that even if one could prove that a consumer is not maximizing utility; this would not constitute a refutation of the neoclassical hypothesis. Because, the premise is:” for all decision makers there is something they maximize”. Since the premise is an “All and Some” statement, it’s neither verifiable nor refutable. Thus if a critique claim to have found a consumer who is not maximizing anything then there could be a claim on how do anybody know the consumer is not maximizing something. In summary to deny the truth of the maximization hypothesis are no more testable than the hypothesis itself. Some economist argued that since the hypothesis is not testable then it must be tautology and as such meaningless. The author argued that statements that are untestable don’t necessarily mean tautology, it might be metaphysical. The maximization hypothesis is not tautology because unlike tautology it is not intrinsically tautology. Its metaphysical status is the result of how it is used in the research program. It is in the form of an existential statement. Every model or theory is merely another attempted test of the robustness of a given metaphysics. Every research program has a foundation of given behavioral or structural assumptions. These assumptions are ranked and the last ordered lists are the metaphysics that define the research program. Maximization hypothesis play this role because it is fundamental to everything. So, whether maximization should be a part of anyone’s metaphysics is a methodological problem. Since, maximization is a part of metaphysics, neoclassical economist employed ad 1

2 . Thus any criticism or defense of neo-classical maximization must deal with neoclassical methodology rather than the truth of the assumption. Since the model predict this ability of firms maximization behavior [f (x) = w ]( no matter how unrealisitic the model is) with its simplicity. a pric taking profit maximizing firm with a constantmarginal cost case is given below: π = py − wx where.C. resides the methodological attitude of most neo-classical economics. The only problem if there is a problem. Friedman’s instrumentalism will say that the truth of assumption doesn’t matter.we should not reject the notion of profit maximization here because the firms don’t have to know this equation/condition but they act “As-If” they do. and then use the predictions to evaluate the model. Milton friedman’s criterion for evaluating models states that models should be evaluated on the basis of their predictive ability not on the realism of there assumptions. Suppose a function is defined on a convex set. His logic is summarized in the above. there are no fixed costs. Thus. Those who reject Friedman’s instrumentalism can argue but the author ended the argument stating that it’s still futile to criticize maximization hypothesis because there’s nothing wrong intrinsically in the maximization hypothesis. Author’s logic is clear cut and he explains beautifully why the maximization hypothesis cannot be criticized. Problem 2. [Hint: do some math. explain why this model is a good or bad model. in our case. y = f (x) F. then it is also quasi-concave.In graph: p ——————————————————————————————————————————| | | | | | | | | | | | | | | | The profit maximizing behavior is determined by the condition f (x) = w . y ∗ )denote the solution.hoc methodology in order to deflect possible criticism.Sinceπ = py − wx.Prove that (a) if the function is concave. By Milton Friedman’s methodolp ogy. pf (x) = w ⇒ f (x) = w p Let (x∗ .Based on Milton Friedman’s criterion for evaluating models. Consider a price-taking profit-maximizing firm with a constant marginal cost.] Answer 2. I could not find any other solid argument against the author’s explanation and it seems to me that the authors argument is plausible enough to justify in agreement with the author. we could say by Milton Friedman’s criterion p that it is a good model. but (b) quasi-concavity of the function does not necessarily imply concavity of the function. y ∗ )is py − wx = π ∗ which has a y intercept equal to π . (b) I agree with the Author. the optimal profit is then π ∗ = py ∗ − wx∗ . get some predictions from the model.O. The iso-profit line ∗ through (x∗ . Problem 3.

x2 ) > 0. x2 ) = pf (x1 . x2 ) = pf (x1 . x2 ) − w1 x1 − w2 x2 . x > y. p) and x∗ (w1 . p. 2 (c) Prove that δx∗ /δw2 = δx∗ /δw1 .The firm’s profit is: π(x1 .D) (b) Let f : D ⊂ R → R be any non-decreasing function on R. Problem 4. specifically state these condition(s). f (y)} + (1 − λ) min{f (x). ∀x ∈ R]. x∗ ). 1) and assuming WLOG. dπ(x∗ . 1 2 (d) Prove that the signs of the derivatives δx∗ /δp and δx∗ /δp are ambiguous. [ Note for example: take f (x) = x3.( Note: all input demands have negative slopes). x2 ) − w1 x1 − w2 x2 . That is. x∗ (w1 .E. w2 . (a) Assuming an interior solution. we have: f (x) ≥ f [λx + (1 − λ)y] ≥ f (y) Since from the first inequality of the above equation.[ Note: strict quasi-concavity 1 2 2 2 of the production function implies −f1 f22 + 2f12 f1 f2 − f2 f11 > 0]. In this case x1 is now the ¯ ¯ ¯ ¯ δx∗∗ δx∗ 1 ¯ only choice variable. explain the intuition for your answer in (e).we have x > λx + (1 − λ)y > y.( and vice-versa for convex). 1 2 (e) Prove that the signs of the derivatives δx∗ /δp and δx∗ /δp cannot both be negative. f (y)} ⇒ f [λx + (1 − λ)y] ≥ min{f (x). 1 2 (f) Let y ∗ = f (x∗ .State the sufficient conditions for a maximum?How are they related to the conditions of the implicit function theorem? (b) Prove that the input demand functions. x2 )is the production function and p > 0 is the price of output. p)are downward-sloping.Prove that δy ∗ /δp > 0. ∀x. w2 . y ∈ D and λ ∈ (0. Consider a profit-maximizing price-taking firm that employes two inputs x1 and x2 with input prices w1 > 0 and w2 > 0. (g) Based on the result in (f). f (y)} (Q. w2 . find an expression for the total differential(change) in profits. f (y)} ⇒Quasi-Concave and since it is always possible to choose a non-decreasing f that is neither concave nor convex on R we have shown that not every quasi-concave function is concave. f (x) = max{f (x). 1 2 (i) Suppose that x2 is fixed at x2 > 0 which gives π(x1 .Suppose that f1 > 0 and f2 > 0. (a) Let f : D ⊂ Rn → R and suppose f is concave. Prove that δw1 < δw1 1 1 1 ( an exapmple of paul Samuelson’s Le Chatelier principle) and give the intuition for this result. Thus ∀x. Answer 4. w1 and w2 and the output price p all change. dw1 anddw2 . Let the firm’s optimal choice (input demand) be x∗∗ = x∗ (w1 . 1).Answer 3. Since f is non-decreasing. y ∈ D and ∀λ ∈ (0. x∗ (w1 . Where y = f (x1 .In this 1 2 context. Denote these changes bydp. 1 δx∗ /δw2 < 0. f (y)} ⇒Quasi-Convex and from the second inequality of the above equation f (y) = min{f (x). what are the first-order conditions? The implicit function theorem states that the conditions under which the solutions. (h) Suppose the input prices. p) to the first-order conditions exist. Using envelope theorem. δx∗ /δw1 < 0 and 1 3 . x∗ )be the profit-maximizing level of output. we have f [λx + (1 − λ)y] ≥ λf (x) + (1 − λ)f (y) ⇒ f [λx + (1 − λ)y] ≥ λ min{f (x).

p) and in the F. p)) − w1 ≡ 0 1 2 π2 = pf2 (x∗ (w1 . w2 . δw∗ = δx2 pf21 pf22 0 δw1 Using Cramer’s rule we have: 1 pf12 ∗ 0 pf22 δx1 = pf22 δw1 = |H| pf11 pf12 pf21 pf22 By the assumption from S. Thus. π1 = 0 and π2 = 0and π π12 =0 |J|= 11 π21 π22 and x∗ = x∗ (w1 .C. δx∗ 1 δw1 < 0 Similarly for δx∗ 2 δw2 differentiating (3) and (4) w. p) Such that the determinant of the matrix of derivatives of the system of equation is non-zero 2 2 (Jacobian). p) 1 1 x∗ = x∗ (w1 . p). w2 .O. p). 1 +p .O. p) exist. Assuming |H| > 0 for maximization gurantee’s |J| = 0. w2 .O. w2 .C’s are π1 = pf1 − w1 = 0 π2 = pf2 − w2 = 0 Implicit function theorem states that the condition: x∗ = x∗ (w1 . x∗ (w1 . we have.t w1 gives: p δf1 δx∗ δf1 δx∗ . w2 . p) 1 1 x∗ = x∗ (w1 . p) 1 1 x∗ = x∗ (w1 . 1 +p .O.t w2 gives: 4 . (b) By implicit function theorem x∗ = x∗ (w1 .O.C: 2 2 π11 π12 >0 |H|= π21 π22 ⇒ |H| = π11 π22 − (π12 )2 > 0 Careful examination of |H| reveals that it is the same of |J| of the derivatives of π1 andπ2 from F. The S. |H| > 0 and f22 < 0 and given p > 0. w2 . 2 −1=0 δx1 δw1 δx2 δw1 p δf2 δx∗ δf2 δx∗ . w2 . p)) − w2 ≡ 0 1 2 Differentiating w.C. x∗ (w1 .r.C we obtain: 2 2 π1 = pf1 (x∗ (w1 . w2 . w2 . w2 .(a)The F.r. 2 =0 δx1 δw1 δx2 δw1 (5) (6) (3) (1) (2) (4) In matrix form: ∗ δx1 pf11 pf12 1 1 .

From equation (4) differentiating w. 2 −1=0 δx1 δw2 δx2 δw2 In matrix form: ∗ δx1 0 pf11 pf12 2 . |H| > 0 and f11 < 0 and given p > 0. from the equation (7) and(8) and from the matrix formit can be written for δw1 using cramer’s rule⇒ 2 0 pf12 1 pf22 δx∗ 1 = pf12 δw2 = |H| pf11 pf12 pf21 pf22 Since. from the S. the hessian is a symmetric negative definite matrix.D] δx∗ 2 δw2 δx∗ <0 (c) From the equation (5) and(6) and from the matrix formit can be written for pf11 1 ∗ pf21 0 δx2 = pf21 δw1 = |H| pf11 pf12 pf21 pf22 δx∗ δx∗ 2 δw1 using cramer’s rule⇒ and. we know: ∗ δπ2 δx2 δw2 .r. δw1 > 0 δπ Since.p p δf1 δx∗ δf1 δx∗ . 2 =0 δx1 δw2 δx2 δw2 (7) (8) δf2 δx∗ δf2 δx∗ .C. δw∗ = δx2 1 pf21 pf22 δw2 Using Cramer’s rule we have: pf11 0 ∗ pf21 1 δx2 = pf11 δw2 = |H| pf11 pf12 pf21 pf22 By similar reasoning. δw1 < 0⇒ δw1 < 0 1 1 Similarly.O. we have. 1 +p .E.C. δx∗ δx∗ 1 2 δw2 = δw1 [Q.D] ANOTHER PROOF: From equation (3) differentiating w. δw2 > 0 δπ Since. he assumption from S.E.t w1 : δπ1 δw1 = −1 < 0 By conjugate pairs theorem.r. 1 +p . δw2 < 0⇒ 2 [Q.we have from youngs theorem: f12 = f21 Thus.E.D] 5 . we know: ∗ δπ1 δx1 δw1 . δx∗ 1 δw2 < 0 [Q.t w2 : δπ2 δw2 = −1 < 0 By conjugate pairs theorem.O.

C. by the assumption from S. |H| > 0.O. p). [Q. p)) ≡ 0 1 2 δx1 δp δx2 δp δx∗ 1 δp : (9) p (10) or in matrix form: ∗ δx1 pf11 pf12 −f1 δp . p)) ≡ 0 1 2 δx1 δp δx2 δp δf2 δx∗ δf2 δx∗ .C. Thus sign( δp1 ) is ambiguous.C equations. Similarly. p). w2 . since by the assumption from S. [Q.O. f1 f21 andf2 f11 are all negative numbers. f1 f22 . x∗ (w1 . δp1 < 0 and δp2 < 0 2 Since. w2 . |H| > 0 and f22 < 0 and given p > 0. w2 .O. 2 + f2 (x∗ (w1 .D] (e) From the previous results we’ve got: δx∗ 2 δp p(f1 f21 −f2 f11 ) 2 p2 (f11 f22 −f12 ) δx∗ 1 δp = p(f2 f12 −f1 f22 ) 2 p2 (f11 f22 −f12 ) and = We will proof by contradiction: δx∗ δx∗ Let.C. i = 1. by S. f1 > 0.(d) By the implicit function theorem and from equation (3) and (4) it can be written for p δf1 δx∗ δf1 δx∗ .O. then f2 f12 . 1 +p .we cannot use the conjugate pairs theorem and sign δx∗ ( δpi . Multiplying equation (11) by equation (12) we get: f1 f2 f21 f12 > f1 f2 f11 f22 2 ⇒ f11 f22 < f12 [f12 = f21 ] 2 ⇒ f11 f22 − f12 < 0 2 Which is a violation of S. f1 > 0. f11 < 0 and f22 < 0 and f1 > 0. It can be viewed as since pappears in both F. (p2 (f11 f22 − f12 ) > 0)by S.C assumption and p > 0 we have: f2 f12 − f1 f22 < 0 ⇒ f2 f12 < f1 f22 f1 f21 − f2 f11 < 0 ⇒ f1 f21 < f2 f11 (11) (12) Since.C that ⇒ f11 f22 − f12 > 0 (contradiction) δx∗ δx∗ So. f2 > 0. 1 +p . f2 > 0 δx∗ but we don’t know the sign(f21 ) and its magnitude. 2 + f1 (x∗ (w1 .E. Thus sign( δp2 ) is ambiguous. w2 .O. we get −f1 pf12 ∗ −f2 pf22 δx1 = p(f2 f12 −f1 f22 ) δp = |H| pf11 pf12 pf21 pf22 Now.E. f2 > 0 but we don’t know δx∗ the sign(f12 ) and its magnitude. by cramer’s rule we can solve: pf11 −f1 ∗ pf21 −f2 δx2 = p(f1 f21 −f2 f11 ) δp = |H| pf11 pf12 pf21 pf22 By similar argument.D] 6 .O. 2) are ambiguous. δx∗ = 2 pf21 pf22 −f2 δp Solving via cramer’s rule. δp1 < 0 and δp2 < 0 cannot be both true. |H| > 0 and f11 < 0 and given p > 0. x∗ (w1 .

D] δy ∗ δp (g) Because of strict-quasi-concavity the production function. the supplyalso increases. p)dw2 1 2 1 2 1 2 (i) Given π(x1 . p). a rise in price means rise in output. w2 ).E. w2 . ⇒ −f12 f12 = −(f12 )2 ≤ 0 Adding f11 f22 to both sides of the inequality we have: f11 f22 − f12 f21 ≤ f11 f22 .As the price increases. p(f2 f12 −f1 f22) + f2 . and since input price of a factor price decreases then to increase the supply function as the price increases. x2 ) = pf (x1 . x∗ ) = pf (x∗ . δp ) ) f1 .(f ) Given. x2 ) − w1 x1 − w2 x2 f x∗ = x∗ (w1 . w2 . Multimlying bothsides with p > 0 yields: ⇒ p(f11 f22 − f12 f21 ) ≤ pf11 f22 . i. π(x∗ . p > 0. (for short run) ¯ ¯ ¯ (for long run) from previously we derived: π1 = pf1 − w1 = 0 π2 = pf2 − w2 = 0 pf pf12 and |H|= 11 pf21 pf22 with S.D] This primciple explains that the firm will respond more to a price change in the long run than short run. (p. p.C becomes: ¯ ¯ ¯ π1 = pf1 (x∗ .O. δp2 δp ⇒ f1 . w2 . The following figure 1 2 explains it: δx∗ δx∗∗ 7 . w2 . x∗ ) − w1 x∗ − w2 x∗ Using the envelop theorem. x∗∗ ) − w1 = 0 1 2 δx∗∗ δx∗ δx∗∗ 1 1 1 Now. x∗ (w1 . the other factor price of factor demand must have increases. and by S.O. x2 ) − w1 x1 − w2 x2 . Since the term in the parentheses is positive by S. Thus we have δw1 = p(f11 f2222 12 f21 ) < 0[The long run case] 2 2 −f 1 ∗∗ ∗∗ x1 = x1 (w1 . p). Since. x2 ) = pf (x1 . the total differential change in 1 2 1 2 1 2 profits : dπ(x∗ (w1 . if. [The short run case]We have to prove: δw1 < δw1 1 Proof: Since.e marginal factor demand is positive (factor prices are positive). p) 1 1 δx∗ δx∗ and π(x1 . δp1 + δx2 .C. w2 . p). w2 .The formula tell’s us how x∗ and x∗ adjust to changes in w1 in the long run given. dividing it we get: 1 ≤ p(f11pf11 f22 f21 ) f22 −f12 Dividing both sides by pf11 < 0 yields f22 1 pf11 ≥ p(f11 f22 −f12 f21 ) 1 ⇒ δw1 < δw1 1 [Q.O. f2 > 0. pf11 < 0. (h) Given. pf22 < 0 and |H| > 0 and x∗ = x∗ (w1 . x∗ (w1 .C. w2 ).So δp1 and δp2 can not both δp δp be negative. f12 = f21. y ∗ = f (x∗ . p))dp − x∗ (w1 . p(f1 f21 −f2 f11) 2 2 p2 (f11 f22 −f12 p2 (f11 f22 −f12 2 2 p(−f1 f22 +2f12 f1 f2 −f2 f11 2 p2 (f11 f22 −f12 ) 2 2 Since. f1 > 0. δx∗ 1 δp < 0 and δx∗ δx∗ 2 δp <0 then δy < 0 which violates our findings δy > 0 that we proved in (f ).C f11 f22 − f12 > 0 and by strict quasi-concavity of the production function −f1 f22 + 2 2f12 f1 f2 − f2 f11 > 0 we have δy ∗ δp > 0 [Q. p)) = f (x∗ (w1 . (p.E. ⇒ ⇒ δx∗ δx∗ 1 2 δp + f2 . w2 . x∗ ) Differentiating with p we get: 1 ∗2 ∗ δy ∗ δf δx δf δx = δx1 . δw1 = pf11 < 0.O. x2 ) > 0and x2 fixed with x2 > 0 the F. w2 . p)dw1 − x∗ (w1 . ∗ ∗ > 0.

y). x).xn ) be the vector of (conditional) input demands.. ˆ ˆ (b) Explain the result in (a)... y) + (1 − λ)c(w.D] (b) The Above results explains that the cost function is concave in input prices.where x is the vector of (conditional) input demands when output is y and the vector of ˆ ˆ ˜ ˆ input prices is w and (w. where w = (w1. y) ≥ λc(w. w2 .. x)and (w. (a) Let w = λw + (1 − λ)w ∀ λ ∈ (0. Answer 5.. 1) ˆ Thus c(w . x2 . y) ˆ ˜ ˆ ˜ [Q. Consider (w.. A competitive firm has the cost function c(w... ˆ ˜ (a) prove that c(λw + (1 − λ)w. y) ˆ ˜ ⇒ c(λwx + (1 − λ)wx . x) is similarly defined.wn ) is the vector of input prices and y > 0 is the output (a scalar). y) ≥ λc(w. y) + (1 − λ)c(w..—————————————————————————————————————————-| | | | | | | | | | | | | | | | Problem 5.E. This reflects the very simple idea of substitutablity. 8 . y).. The cost function increases less than proportionately when one input price increases because the firm can substitute it by other inputs.. Let x = (x1. y) ≥ λc(w. y) = w x = λwx + (1 − λ)wx Since x is not necessarily the cheapest way to produce y at price w ˆ ˜ ˆ or w we have: ˜ wx ≥ c(w. y). ˆ ˆ ˜ ˜ ⇒ c(w . y) and wx ≥ c(w. y) + (1 − λ)c(w..

Sign up to vote on this title
UsefulNot useful