Econ 200 Problem Sets

September 29, 2014

Schedule: Lectures take place Monday, Wednesday 12:00pm-1:20pm, Room 021, Saieh Hall, while TA
sessions take place Thursday 6:00pm-6:50pm, Room 402, Cobb Hall.
Instructor: Bradley J. Setzler, PhD Candidate ([email protected]).
Assistant: Mohsen Mirtaher, PhD Student ([email protected]).
Overview: These problem sets apply the economic theory covered in lectures to specific problems. They
require the main analytic tools of the economics profession. Graded problem sets are returned to
students one week after they are turned in.
Rules: Each problem set is due at exactly 6:00pm on the specified due date. The TA sessions reveal the
solutions to the problems, so late problem sets will not be accepted.
Questions: Mohsen is in charge of grading the problem sets, leading TA sessions, and answering questions.
He can be contacted using the email address above.
Note: These problem sets were written by Bradley. This means that the problem sets contained in Victor
Limas notes are available for you to use for extra practice when preparing for exams.

Problem Set 0: Math Review, Due Oct. 2 (1st TA Session)

Consider the function f (x, y) = log (xy). (In economics, log always means natural log, unless otherwise
noted.)

Problem 0.1
(i) What is the derivative of f with respect to y? Denote this by fy . (ii) What is the second derivative of f
with respect to y? (iii) What is the derivative of fy with respect to x?

Problem 0.2
Using a Lagrange multiplier technique, determine the maximum value of f that can be attained on the plane
defined by x + y = c, where c > 0 is a finite constant.

Problem Set 1: Scarcity, Due Oct. 9 (2nd TA Session)

Consider an agent with budget constraint m = px x + py y, where m is income, px is the price of x, and py is
the price of y.

Problem 1.1
How much x can the agent afford? Can the agent afford more x or more y?

Problem 1.2
How much x must the agent give up in order to obtain an additional unit of y?

Problem 1.3
(i) Draw a graph of the budget constraint. (ii) Label the area of the graph that the agent can afford and the
area that the agent cannot afford. (iii) Represent the solution to Problem 1.1 on the graph. (iv) Represent
the solution to Problem 1.2 on the graph.

Problem 1.4
(i) Demonstrate graphically that, if the agent likes more of x and more of y, then he is better off when
income m increases. (ii) Demonstrate graphically that, if the agent likes more of x and more of y, then he
is worse off when px increases. Note: this question requires no consideration of utility functions.

Problem Set 2: Utility Properties, Due Oct. 16 (3rd TA Session)

For the following cases, answer the following: (i) Determine if utility is increasing in each argument. (ii)
Determine if utility is concave in each argument. (iii) Derive the marginal rate of substitution. (iv) Graph
a few indifference curves.

Problem 2.1
Cobb-Douglas: u (x, y) = x y 1 .

Problem 2.2
1

Constant elasticity of substitution: u (x, y) = (x + (1 ) y ) .

Problem 2.3
Quasilinear: u (x, y) = log x + y.

Problem 2.4
Perfect complements: u (x, y) = min {ax, by}.

Problem 2.5
Perfect substitutes: u (x, y) = cx + dy.

Problem Set 3: Utility Maximization - Due Oct. 23 (4th TA session)

This problem set analyzes the behavior of a utility maximizing agent facing fixed prices and income (this is
called Marshallian analysis). Here are some definitions that may be useful:
Cobb-Douglas utility over x and y is given by U (x, y) = x y 1 .
If f (px , py , m) is the Marshallian demand function for good x, then we say that x is a normal good if
df (px ,py ,m)
df (px ,py ,m)
> 0 and x is an inferior good if
< 0.
dm
dm
If f (px , py , m) is the Marshallian demand function for good x, then we say that x is a gross (or
df (px ,py ,m)
df (px ,py ,m)
uncompensated) complement for y if
< 0 and x is a gross substitute for y if
> 0.
dpy
dpy
You may assume the budget constraint is m = px x + py y, for prices px > 0, py > 0 and income m > 0.

Problem 3.1
Maximize Cobb-Douglas utility subject to the budget constraint. In particular, find (i) Marshallian demand,
(ii) indirect utility and (iii) the Lagrange multiplier. Note: each of these should be expressed as functions of
only the Cobb-Douglas preference parameter (0, 1), prices, and income.

Problem 3.2
(i) How much does the demand for x change when px increases marginally? (ii) How much does the indirect
utility change when income increases marginally? (iii) Is x a gross complement, gross substitute or neither for
y? (iv) Is demand normal or inferior for each good, and does this result depend on the particular combination
of parameters?

Problem 3.3
An economist wants to predict the effects of a decrease in the price of x, holding the price of y and income
fixed. Based on his previous knowledge of the markets for x and y, he believes that a fall in the price of x will
increase demand for both x and y. (i) Should the economist use a Cobb-Douglas utility function to represent
the consumer? (ii) If Cobb-Douglas is inappropriate for this purpose, give an example and justification of a
utility function that makes more sense.

Problem 3.4
(1)m
An economist believes that Marshallian demands for x and y are m
, respectively. Using only
px and
py
this information, can the economist determine (i) the utility function or (ii) the number of utils that the
consumer will gain from a marginal increase in income?

Problem Set 4: Duality, Due Oct. 28 (5th TA Session)

For each of the following cases, (i) derive the Marshallian and Hicksian demand functions, (ii) carefully state
the income and substitution effects, and (iii) prove that the Slutsky Equation holds.

Problem 4.1
1

Constant elasticity of substitution: u (x, y) = (x + (1 ) y ) .

Problem 4.2
Log-linear: u (x, y) = log x + y.

Problem 4.3
Perfect complements: u (x, y) = min {ax, by}.

Problem 4.4
Perfect substitutes: u (x, y) = cx + dy.

Problem Set 5: Labor Supply, Due Nov. 6 (6th TA Session)

Consider a consumer with Cobb-Douglas utility over leisure R and consumption C given by U (C, R) =
C R1 . There are T hours of time, he has fixed income V , he receives wage W per hour and consumption
costs P per unit.

Problem 5.1
In what sense does this agent have an endowment?

Problem 5.2
Will the agent supply labor? If so, how much? If not, would a higher wage make the agent work?

Problem 5.3
Are consumption and leisure gross complements or substitutes?

Problem 5.4
How does leisure depend on W and V ?

Problem Set 6: Saving and Borrowing, Due Nov. 13 (7th TA Session)

Consider a consumer who lives two periods with utility over period 1 and period 2 consumption, c1 and c2 ,
given by U (c1 , c2 ) = 1 c1 + 1 c2 , and endowments 1 > 0 in period 1 and 2 > 0 in period 2 and interest
rate r > 0, and (0, 1).

Problem 6.1
State the budget constraint. Which is cheaper: first period consumption or second period consumption?
Why?

Problem 6.2
Determine optimal consumption across the two periods.

Problem 6.3
Determine if the consumer borrows or saves in each of the following cases: (i) (1 + r) > 1, (ii) (1 + r) = 1,
(iii) (1 + r) < 1. (iv) How does the magnitude of savings depend on ? Interpet .

Problem 6.4
Is consumption in period 1 a substitute for consumption in period 2? Is consumption in each period normal
or inferior?

Problem 6.5
Derive and interpret how savings change in response to a marginal increase in the interest rate.

Problem Set 7: General Equilibrium, Due Nov. 20 (8th TA Session)

Imagine two consumers with Cobb-Douglas utility on an island. The first consumer has preference parameter
1 (0, 1) and endowments x1 > 0, y1 > 0, and the second consumer has preference parameter 2 (0, 1)
and endowments x2 > 0, y2 > 0. Denote the aggregate endowments by
x = x1 + x2 and
y = y1 + y2 .

Problem 7.1
Find the equilibrium prices and consumption allocation on the island. Verify that Walras law holds.

Problem 7.2
Using a Lagrangean, solve the planners problem on this island for allocations, the Lagrange multiplier and
find the transfers.

Problem 7.3
Are the equilibrium and planners allocations the same? How do equilibrium prices relate to the planners
Lagrange multiplier?

Problem 7.4
Suppose that = 1 = 2 so that the two consumers have identical preferences and denote the endowment
1

shares by 1x = xx , 2x = xx , 1y = yy , 2y = yy . Express the competitive equilibrium and planners allocation

as functions of , aggregate endowments and endowment shares. Use these expressions to interpret the
importance of the preference parameter and the endowment distribution in the competitive economy.