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Eco501 Assignment1 Solutions Summer2020

This document contains solutions to problems from an advanced microeconomics assignment. Problem 1-1 asks to find the extreme point and value of a quadratic function, and determine if it is a maximum or minimum. The solution finds the point (4,3) that maximizes the function at 176. Problem 1-2 asks to minimize another function subject to a constraint. The solution uses Lagrange multipliers to find the constrained minimum at the point (75,51,-144). Problem 1-3 calculates the market equilibrium price and quantity for a one-commodity market, and derives the comparative static derivatives with respect to the parameters.

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269 views

Eco501 Assignment1 Solutions Summer2020

This document contains solutions to problems from an advanced microeconomics assignment. Problem 1-1 asks to find the extreme point and value of a quadratic function, and determine if it is a maximum or minimum. The solution finds the point (4,3) that maximizes the function at 176. Problem 1-2 asks to minimize another function subject to a constraint. The solution uses Lagrange multipliers to find the constrained minimum at the point (75,51,-144). Problem 1-3 calculates the market equilibrium price and quantity for a one-commodity market, and derives the comparative static derivatives with respect to the parameters.

Uploaded by

maruf91
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Summer 2020

Department of Economics, East West University


ECO 501: Advanced Microeconomics
Assignment # 1 – Solutions

1-1. Find the extreme point and extreme value of the quadratic function f (x, y) = 60x +
34y − 4xy − 6x2 − 3y 2 + 5. Also, check second order conditions to determine whether the
extreme is a maximum or a minimum. (Hint: use the bordered Hessian determinant)
Answer: To find the extreme values, set the first partial derivatives equal to zero,
fx = 60 − 4y − 12x = 0 (1)
fy = 34 − 4x − 6y = 0 (2)
which can solved to obtain (x? , y ? ) = (4, 3). Substituting these values in the function,
we can obtain the stationary point (x? , y ? , f (x? , y ? )) = (4, 3, 176). To check whether this
point is maximum or a minimum, write down the Hessian matrix of second derivatives
as follows:
   
fxx fxy −12 −4
H = = (3)
fyx fyy −4 −6
2
Note that fxx = −12 < 0, fyy = −6 < 0 and that fxx fyy − fxy = |H| = 56 > 0. So, the
function is maximized at (4, 3, 176).

1-2. Minimize the function f (x, y) = 3x2 +5xy +6y 2 , subject to the constraint 5x+7y = 732.
Use second order conditions to check that the function is, indeed, minimized. (hint: use
the bordered Hessian determinant)
Answer: The optimization problem is to:
Minimize: 3x2 + 5xy + 6y 2
{x,y}

s.t.: 5x + 7y = 732

The Lagrange for the problem is:


L(x, y, λ) = 3x2 + 5xy + 6y 2 + λ[5x + 7y − 732]

The first order conditions are:


∂L
Lx = : 6x + 5y + 5λ = 0 (1)
∂x
∂L
Ly = : 5x + 12y + 7λ = 0 (2)
∂y
∂L
Lλ = : 5x + 7y − 732 = 0 (3)
∂λ
The three equations, (1), (2), and (3), can be solved using different methods. Here, I
use the Cramer’s rule and so I write the equations in matrix form as:
    
6 5 5 x 0
    
 5 12 7   y  =  0 
    
5 7 0 λ 732

First, calculate the determinant of the coefficient matrix, |A| = −244. Now, form the
following three matrices and calculate their determinants:

0 5 5 6 5 5 6 5 5


|A1 | = 0 12 7 ; |A1 | = 5 12 7 ; |A1 | = 5 12 7

732 7 0 5 7 0 5 7 0

Therefore, the solutions are:


|A1 | −18300 |A2 | −12444
x? = = = 75; y? = = = 51;
|A| −244 |A| −244
|A3 | 34404
λ? = = = −144;
|A| −244

which means the critical value is {75, 51, −144}.


Now, check the second order conditions using the bordered Hessian matrix:
  
Lxx Lxy Lxλ 6 5 5

   
|H| =  Lyx Lyy Lyλ  =  5 12 7  = −244 < 0
 
   
Lλx Lλy Lλλ 5 7 0

Therefore, {75, 51, −144} is a constrained minimum.

1-3. Consider a one-commodity market model:

Q = a − bP (demand)
Q = −c + dP (supply)

where a, b, c, d > 0 are exogenous parameters.

(a) Calculate market equilibrium price and quantity (P ? , Q? ).


(b) Calculate all comparative static derivatives.

2
Answer:
(a) Set quantity demanded equal to quantity supplied:

a − bP = −c + dP
a+c
P? = (equilibrium price)
b+d

Substitute in the demand or supply equation to obtain:


 
? a+c ad − bc
Q = a−b ⇒ Q? = (equilibrium quantity)
b+d b+d

(b) The comparative static derivatives are as follows:

∂P ? 1 ∂P ? 1 ∂P ? a+c ∂P ? a+c
= , = , =− , =− ,
∂a b+d ∂c b+d ∂b (b + d)2 ∂d (b + d)2

∂Q? d ∂Q? b ∂Q? (c − a)d ∂Q? b(a + c)


= , =− , =− , =− .
∂a b+d ∂c b+d ∂b (b + d)2 ∂d (b + d)2

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