Section 3:

Consumer Theory

2. [12 points]

Suppose the consumers in this problem are competitive. This is true

for both parts (a) and (b) of this question! For simplicity, assume there
is bnly one consumer (this just saves on notation). This consumer only
consumes two goods, X and Y. Suppose this consumer's income is $10,
the price of good X is $2/unit, and the price of good Y is $l/unit.
Suppose the consumer's utility function is X 1/ 2yl/2.
(a) How much X and Y will this consumer buy? Be sure to verify
the second-order conditions.
(b) Suppose when this consumer goes to the store to buy X and Y, he
can only find 4 units of Y in the store. (This should be less than
the amount you calculated that he desired to buy in part (a).)
What do you think will happen? Bidding the price of good Y
up? In the end, how much X and Y will he end up with?
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Answer all

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1. Suppose a consumer's utility fun~tion u is given by u(x) =

Xl and X2 are amounts of two commodities consumed.

(a) Is this utility function concave?

(b) Find the utility-maxhriizing demand for 'Xl and for

Xl

x~ where
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X2.
1111

(c) Are the second-order sufficient conditions for a maximum satisfied

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 5. If a consumer has a standard budget constraint and a utility function

u(x), =
+ x2) what conditions on CY have to be satisfied if the
consmuer is to be able to maximize utility at an interior point? (Hint:
second-order conditions.)

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2. I suggest you read both parts of this question before you begin to work
on the first part.
(a) Suppose a consumer has a quasiconcave utility function u(x)
where x Rn . Prove that if
x satisfies the first-order conditions for the problem
max u(x)
x

s.t. p x = m

(1)

where p are the prices (which the consumer takes as

given) and m is income,
then
x must actually solve (1).
(b) Show that if the consumer does not take p as given, but rather has
some influence over itsay he receives lower prices for a particular commodity if he buys a great deal of itthen it is no longer
necessarily true that if x satisfies the first-order conditions for
(1) then x must actually solve (1).

2005 Qualifier, Section 2

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2. [14 points] Suppose a person consumes two goods, x and y. The price
of x is $0.50 per unit (that is, $1/2 per unit). The price of y reflects a
volume discount, and is
1 0.12y
as long as that is positive. The consumers income is $2. This consumers affordable set is the shaded area in the graph below.
Suppose this consumers utility function is
x+y+

1
10

ln x +

1
10

ln y .

Some of this consumers indifference curves are shown in the graph

below.
4

0
0

(a) Show that the utility function is strictly concave.

(b) Show that any (x , y , ) satisfying

2.4y 2 10y
1

+ y 0.12y 2
10 4.8y 2 10y + 1
1
2.4y 2 10y
x=
5 4.8y 2 10y + 1
1
=2+
5x
2=

(or an equivalent set of equations) satisfies the first-order conditions for utility maximization. (These equations should have been
written as functions of x , y , and , but I omitted the asterisks
for enhanced legibility.) Do not try to solve the system for y , x ,
or .
(c) What sufficient condition would ensure that a vector (x , y , )
satisfying the conditions of part (b) actually is a maximum? Your
answer should be a function of x , y , and , but you can omit
the asterisks for enhanced legibility.
(d) It can be shown that (x , y , ) = (0.704259, 2.26171, 2.28399)
satisfies the conditions of part (b). This point is marked as a dot
on the graph. However, it violates the condition of part (c) (do
not prove this; take my word for it). What is the implication of
this violation? Could you have predicted this violation?
(e) What do you guess the consumers utility-maximizing bundle is?
Why? (I am asking for a guess here, not a mathematical investigation.)

Summer 2012, Qualifying Exam, Section 1 Qu. 2

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2. [11 points] Suppose a utility-maximizing consumer does not take prices

as given. You should represent the prices of the two commodities x1
and x2 he may consume by p1 (x1 ) and p2 (x2 ), respectively.
(a) What are the sufficient conditions for a utility maximum? Your
answer may include , x1 , and x2 .
(b) Presuming the conditions in (a) are satisfied, what else needs to
be true in order for x1 to be a normal good?

Fall 2010 Ex. 1 Qu. 2

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3. Suppose a COllsumer buys only two goods, Xl and X2, from his fixed
income m.The prices' for tl{e two goods are PI and pz, respectively.
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of Xl to fall? (Your answer may coiltain A*, xi, and x:n.

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1. [11 points] S:uppose a price-taking consumer receives utility from two

goods, Xl and. X2' How, does the consumer's demand for good 1 change
when the consumer's' income changes infinitesimally?

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5. Suppose a consumer receives utility from two goods

Xl

and

X2

(a) How does this consumer's demand for good 1 change when PI
changes infinitesimally?
(b) How doesihis consumer's demand for good 1 change when P2
changes infinitesimally?
...
(c) Express, as a function of the change in Pbhow this consumer's
demand for good 1 changes when: "PI and P2 change simultaneously in such a way that PI + P2 is unchanged."
III' ,

I II

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2. [10 points] Suppose a consumer has a standard budget constraint and

has a utility function of the form
,

'2-600

where a E (0,1) and j3 >

o.

(a) Find the Marshallian demand for

III

Xl.

,i\l'

(b) How does the Marshallian demand for

Why?
(c) Find the Hicksian demand for

change as j3 changes?

Xl.

(d) How does the Hicksian demand for

Xl

Xl

change as j3 changes? Why?

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V2. [16 points] Suppose a consumer's utility function takes the form u(x, V)
and is quasiconcave. Suppose the consumer's income is fixed at m.
Under what conditions on u will x be an inferior good?
I

To receive full credit, your answer should involve only u or its derivatives.

" (You lose five points if you have to ask me to give you the definition
.
of an "inferior good.") .

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5. [14 points] Consider a consumer who has a quasi-concave utility function defined over two goods. Determine, if possible, the sign of the
slope of this consumer's Hicksian demand curve for good 1 if the consumer does not take the price of good 2 as given, but rather considers
the price of good 2 to be a function of how much of good 2 he consumes.


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Answer all of the foll~wing three questions.

1.. [llpointsj Suppose a consumer's utility function is given by a quas}-

concave function U(Xl, X2).

(a) Suppose the consumer takes the price of Xl as given and the price
of X2 as given. Call these prices Pl and P2. Let income be m .
. ImpliGitly findthe consumer's demand for Xl and X2 and verify
that these demands actually do maximize the consumer's utility.
(b) Suppose the consumer takes the price of Xl as given, but the
consumer faces a price of X2 which declines the more ofx2 the
consumer buys. Implicitly find the consumer's demand for Xl
and X2 and try to verify that these de:rnands actually do maximize
the consumer's utiiity.

Proposition 2. [T~st of Pseudoconvexity.] Let f be a C 2 function

defined in an open, convex set S in Rn. Define the "bordered Hessian"
determinants O'l'(x)" r =: 1, ... , n by
0

O'l'(x)

fi(x)
=:

fi(x)
i{'l (x)

...
" .

f;(x)
ff~(x)

..

f~(x)

f~/l (x)

t=~20ob

f~~(x)

. (?K . {

A sufficient condition for f to be pseudo convex is that O'l'(x) .( 0 for r

. , ., n, and all X E S . .
[Proposition 2': Similarly, a sufficient condition for

=:

2 '
' ,

f to be pseudo concave is that or(X)

alternate in sigJ.? beginning wi,th > 0 for r = 2, " . , n, and all XES.]

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4. [11 points] Compose a problem of economic importance which involves

quasiconcavity. Then work the problem you composed and demonstrate
the importance of quasiconcavity in your mathematical working-out of
that p:t:oblem.

/"",:

."

2. [11 poi:nts] Suppose a price-taking consumer has income m and utility'

,.function u ' In y + lnz where yand z are the two goods which the"
consumer buys. For this consumer, calculate separately the left.:hand
side' and right-hand side of the Slutsky Equation

8xy(p, m) _ 8hy(p, v(p, m)) _ 8xy(p, m)

- ' p8z
8m
, 8pz

Xz

(
)
p,m

,(where X denotes the Marshalliandemand curve and h the Hicksian

demand curve), 'and show that the left-:-hand side is equal to the righthand side. (In the pr~cess, it helps to calculate the consumer's indirect
utility function.)

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by J hrt'a ~
C)

~ ~ ,.. }11r..~ ~ I!:tvh~

fI"PbLem)

:; ~ ~ r

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.......

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l\I'(fl

m)~

('='

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8 I'Y'

t7 yn

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z
..l
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-,
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3. [11 points] Suppose a consumer consumes two goods, x1 and x2 , and

has a utility function of
1/2 1/2

u(x) = x1 x2 .
This consumer takes the prices of the goods p1 and p2 as given, and
has a fixed income m.
(a) Find the consumers Hicksian demand curve for good 1, h1 (p, u),
without explicitly solving a utility-maximization problem.
(b) Find this consumers expenditure function. Hint: one way of writing this consumers expenditure function is


p2
p1

1/2


p1 u +

p1
p2

1/2
p2 u .

(c) Find this consumers indirect utility function from this consumers
expenditure function. Hint: one way of writing this consumers
indirect utility function is
1/2 1/2
p2 .

mp1

(d) Derive this consumers Marshallian demand function for good 1

from the consumers indirect utility function.
(e) Using your answers to parts (a) and (d), verify the Slutsky equation
h1
x1
x1
=
x1
p1
p1
m
for this consumer. (In other words, calculate each side of this equation separately, then show that they are equal to each other.) If
you need this consumers Marshallian demand function for good 2
in order to solve this problem, you may deduce its form by symmetry from the answer to part (d) instead of deriving it.
Fall 2012 Exam 1

) 71-.
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.

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I

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vse

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q~+fD,\ ~

2. Suppose a consumer's expenditure function e(p, u) is equal topl'P~-au;'

. where the p's denote prices and u denotes a utility level.
(a) Find the consumet's Hicksian demand qlrve for good 2, h2(p, u).
(b) Fjnd the consumer's Marshallian demand turve for good 2, X2 (p, m), ,
where m is income.
.
.'.
(c) Verify the following Slutsky equation for this consumer:
8X2(p, m)_ 8h2(p, u) _
J:l

. UP2

J:l

UP2

(
X2

p,m

) {)X2(p, m)
J:l

urn,

III'

II

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4V'5wer d..
I'

b)

S/I1CR.

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,....

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,....

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-= -

hL"

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..:.2.

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a c.ovJ.~.

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~...

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(J;)

4. Suppose a consumer has a standard budget' constraint and a utility

function ,u(x) = Xl +
Find this consumer's indirect 'utility ftmction.

!X2.

. <Qv.ed-,'Olfl !-f

till

'1\

F~n(!!1

,,

E.-)(\t

:loaD

(j)

~Yisvver t;
I I

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~:t

.'~

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). =

11

.J-

.:=

1"

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~/,

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2f, =>

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be.

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-k

t< " " ' ;

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r:"I1., a...1 v/'i!;

tk..

m/pi

=.

t _

fr - 2pz..
~
2.

flo

-f. D(

'l2.

J'h-/c.nw

$p!v-hb",. (7L.. i~4i~u..

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~ (n~ <e. :, ~ ),'7.) . ! f f, >.ll'z, -Ii...

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~ I/f{~
If

11 =>

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if P,
if

<

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if P, >2 fz

i)

1- WI
.2..

',

f'

/
(.fiJi Ct

~)

Il2 :::_
" j?).

Answer all of the following five questions.

1. [8 points] Give a two-dimensional graphical interpretation of the result
that the indirect utility function is quasiconvex in prices.

/h lLcd:t7~' ~ ~ ~Jc-t

ftUdF

~ be. ~ ~ U?c M t Si~ ce /f/ I"J rt:-JI~~f.?(

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s-f;s w(:fL1--

itl1 e d~ Iu~

-lie td:.

,':' ;

1. [11 points] Suppose a consumer receives utility from consumption of

two goods, Xl and X2, according to the utility function x~ x~l-a), where
aE(O,l)~

(a) Find this consumer's indirect utility function.

(b) Verify that this consumer's indirect utility function is quasiconvex
in p. Directly check for quasiconvexitYi do not use the result that
a convex function is quasiconvex, and do not use the result that
a strictly convex function is quasiconvex. (If you could not solve
part (a), then work part (b) with the indirect utility function
hl m - a In PI - (1 - a) In P2, which mayor may not be the correct
answer to part (a).)

CD

See Var(~ /1/.

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ti

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~

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1<_.'

2. [11 points] Suppose a price-taking consumer has

u(x)
over two goods Xl and

autility function

= 2lnxl +lnx2

X2.

(a) Show that this consumer's indirect utility function is

2m
m
v(p,m) = 21n- +In-

3Pl

3P2

where PI is the price of the first good, P2 is the price of the second
good, and m is income.
(b) If the price of the first good rises, what change in income would
leave utility unchanged? [Hint: It is possible to use the indirect
utility function from part (a) in answering part (b).J

a)

U::-

2A"tG,

+A"1-i-

;! ~

2 4X,

~L 7'2-

of-). (rn - ft x,

r:,J

Ie

..:.. 1. ~ h
X, . X'2f1-

X '" .ll 1- I '/lvh 6v.ljd-

11-

t..

2-

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~Jdn..")",+ ~7

: : r X(
l

.3

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2>011 ";:: /)..

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:::

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IJ)

;:: '2

f, X I

1--"2-

'If.

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3f:

of-

Pi

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+-~ 3f2'

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,
2-. (w) (-2-Yq)
?:.,E1
t ~ -L) I
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3r l
(

YII

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+(

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~)JY>1

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-'2..

= p;dpl
\\1\ /7Yd.R.tk oIv

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~

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:::::.>

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;::-

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II '3 FI 5 f7..
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Qv~S+"iO\,\

.3

3. Suppose a consumer's utility function u is given by u(x) = x~/2 + 2X2

wherE! Xl and X2 are amounts of two commodities consumed. Find this, "
consumer'sindirect utility function and expenditure funciion.
'

II

II

I.

~xqYl11

t ~O\~
AV1~uJ~\

:9

;yit

,;-zV"

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, 'tV' (

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, \ql1 la

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I!

2. Supp~se a consumer obtains utility.from consumption of two goods, Xl

and X2, according to the utility function u(x) = x~ X2' This consumer's
incom~ is denoted by m. The consumer takes the price of the second
good as a constant,P2' However, the consumer's actions influence Pl,
the price of the first good; PI increases with the consumer'S purchases
of Xl according to the relationship PI = xl/3.

(a) Find this consumer's indirect utility funCtion.

(b) Find this consumer's expenditure functi,on.

I,

t:xL\VI!\ \

\ q9 (p

An )We-I

~ly,.
,.. )5. t.
I'

;)..

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1t19w
AVl )W~r d
1\1

(1)

.x ~

=)

( c) -~ Ai" ==

s-kJvk 1L~

tont. ~ .

,!\II

t).;t," .

Af2.

I\-fs, (a.) .J.o

)1A,

diViDe

=)

ob tr:.1..- .

-L

3 XI

z.

..,

r,.' XJ..,

"I'

_1 2.. 2 2- 3 X( +-x
3 (
-1..'

r~

'.

r,'

..
~."~

:3 " v

f.,.,

'"

'"

b)

'IT
",

(f,
f'-,

e ( F, ...))

=!L

',s" ),4&~

dtJ;~ . l!<;>.~

II

f "f- tJ..), 1/....; i"-pL:<:s .

I"

. ,I'

III

;1\1

'I

4. Suppos~a consumer's expenditure function is

h'AOi !

eX'C\w:\

'\9?!2r
qOCS+i'OV)

Lf
'Q)

I1III

Find the consumer's

(di~ect)

utility function.
I II

e CPI k 0)

@
I>t

,....

~ [It) ~ ( rfi)
.

1- t:L

..

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.

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.

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4nswtr Lf fj;v1+...
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1

. I

f ~1:'J,~l< +(, ,,,,f.,

/ ';: f, X f

1l. ""'.1.-...--*,

-1-

o,M = J'.

eo.

,I

. I II

Xd- f. y.z -/

3. [11 points] Suppose a consumer's indirect utility function is given by

v(p,m) = Inm - alnpl - (1- a) Inp2.

Find this consumer's:

(a) expenditure function;
(b) (direct) utility function.

(j)

1r ~ A

a)

I' ec.e, /4)) -::: LA--

Ijf"

r, - 0- d-) ~ f2-

a. 4

WI -

S.o

""

etv.) - a. k

fI - (1-tL) 4(2. ::: u-

) SQ/v~

t.r

(r -) ,
r-

e (r,
""

IA.);;: tt A f' + (I-a,) ~(t ..;

I
a..
I-a..
:= A-. fl
.;..~ ('2+ lA.

-: : 4

I .... &...

fl tt

.... ('2-

f-

fA.

~ e

1.1-

L-tr---'

a.'k
~ ;

/J "
r...
a.J. I. e

II

~lo.tJIntS,

-~
(

e f,

N../e.:

Jt,. 'f tv./I".<

t..

....

/ .. a. u....

4.

_ /J
4.

(I!~

fl f-z.

J"'I1..

IA.ly) :::

F. O.C.

~:'s e .";) , ..L-vI.. ~

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tv.e Ix!l'e..- Se.

So

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6)

SD

II

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IS

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+- (I-~)

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+ -4.

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41;..f~+:S ~

lr~thti

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et

t{.

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~ I ~ 4-

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XI 'iY]...
L--v---'

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fy,~J-ku-..diol-\..

uklr.t:J
rpft')M~

,r'(f

~\,(\O( lEx-aWl
\~9y

QU-l5+r-0V\

;L

CD.

2. Suppose the indirect utility function of a cons;umer is given by

.

v(p,m)

4m 3

= 27

2'

PIP2

(a) Find the (direct) utility function.

(b) Find the Hicksian demand curve for good 1.

lit'

, I,

nAC\1

SX4M

\~~11

AhSWL\ :l.

"') tdtl = 'j"- 1r{!, i) s.-/:.. !t

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Qv-6+rOV\ -3
'. Question 3;..1 a consumer's expenditure function is e(p, u) = (pI
find t h e ' c o n s u m e r ' s :
a)
b)

(direct) utility function;

Marshallian demand curve for good 2;

c)

Hicksian demand curve fo~ good 2. "

+ P2')11r u ,
.,

If you decide to solve an optimization problem when you answer this question,
you de net have to. verify that the second-order conditiens hold, but yeu do.,
have to. state the secend-erder cenditions. In stating these second-order
cenditiens, it is acceptable to. leave derivatives unevaluated, as leng as the
only things yeu have left undene are siI;llple differentiatiens.

Ill',

III

1'2-

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1. [11 points] Suppose the expenditure function of a consumer is e(p, u) =

(pr1 + pr2 )1/r u where p1 and p2 are prices, p is the vector (p1 , p2 ), and u
is utility. Find this consumers Marshallian demand curves.

Fall 2011, Exam 1 Qu 1

E.x~M

"LOOq
QV,0.;+rO/1 1..G)

I'

2. [11 points] Suppose a consumer has utipty function U(Xl,X2) = In Xl +

In X2 where Xl and X2 are quantities of two goods. Suppose the consumer's income is m and let the prices of the goods be PI andp2
respectively.
(a) Find the consumer's Marshallian demand curves. (Hint: the answers are xi = m/(2pl) and X2 = m/(2P2)')
(b) State and verify the second-order conditions.
(c) By using the Slutsky equation, ~d how the consumer's Hicksian (Le., "compensated") demand curve for the first commodity
varies as P2 varies. (I want a formula for the appropriate derivative.) (Hint: the answer is m/(4plP2).)
(d) Find the indirect utility function. (Hint: one way of writing the
answer is In[m2 /(4PIP2)].)

(e) Find the expenditure function. (Hint: the answer is 2JPIP2 eU / 2

where "e" is the irrational number 2.718 ....)
(f) From the expenditure function, derive the cOnSumer's Hitksian
demand curve for the first good and find how this demand changes
with changes in P2. (Hint: the answer is eu / 2/(2JPIP2).)
(g) Verify that the answers to parts (c) and (f) are the salne. You
may want to use part (d) to help.
(h) How does the consumer's Hicksian demand curve for the second
commodity vary as.Pl varies?

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1. [20 points] Suppose a price-taking consumer consumes two commodities x and y and has a utility function of the form

u(x,y)

alnx

+ j3lny.

Suppose the price of x is Px and the price of y is Py.

(a) Show that this consumer's indirect utility function can be written
as
aCi.j3f3mCi.+f3 ]
[
v(Px,Tiy, m) = In p~p~(a + j3)Ci.+f3
where m is the consumer's income.
(b) Show that this consumer's expenditure function is

(c) Form this consumer's money metric indirect utility function,

Your final expression should not explicitly involve the indirect

utility function v.
(d) Briefly explain the economic interpretation of your answer to part (c).

co

II.

a,)

(X. :J)

" " 4"

/11\~ X

.,;t"

().

01.

s. t.

"f5 ... 7
I'Y\:;'

FIC ~ +-

p) J

l.."/.f;S 1..J " ).. [ '" - fx t.

o = '.;('/<1).:=

!?'I -

f)(

;t -

~ J

~ J]

b) ;; in u

v- (

r,

e (f'''))

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vt

1r (

f;t fJ
J

~ 4

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0{

t ,.
e

115
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/lle

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ol..,l.
==

I~

USe

fit.

fwtt.e

0(+;3

(.J /

I,m)

=:

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ot

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fWD

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1. [13 points] Suppose a price-taking consumer consumes two commodities x and y and has an indirect utility function of the form


m+
v(
px , py , m) = ln
px py ( + )+
where m is the consumers income, px is the price of x, and py is the
price of y.
(a) Show that this consumers expenditure function is

e(
px , py , u) = ( + )

px py

1
! +


exp

u
+

where exponentiation is denoted by exp to avoid confusion with

the notation for the expenditure function e.
(b) Form this consumers money metric indirect utility function,
(
px , py ; px , py , m) e(
px , py , v(
px , py , m)) .
Your final expression should not explicitly involve the indirect
utility function v.
(c) Show that this consumers utility function is either
u(x, y) = ln x + ln y
or a monotonically increasing function of this (such as x y ).

Summer 2011 qualifying exam, Sec. 1 Qu. 1

AMtA.c

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it

~'J

a) w~ \<~ow ~

IV

pvUh'OI1

dosel')

{PI
A.

~,

II

e ~I

'\f

~ 1e..-kJ ft, Ft<.ll 2.00~

e ( P, LA.))

= u.,

"....,

{r ,e) :: u-

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,...

e
Our

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caSe.

t1{ I

F,.".,d Ex.tWvI

~v~J~ :L. ]

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;t:=

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F. o. c. ~

4. P"r. -P.t.... f)

o~ ~ ::
8px

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+).

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/I.-

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is

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IX

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4.X+-fS 4) .

1'4fN ~ .JJ,q

S~

 Quod(~1~ ~x'(\yY\
,q~r

Q\J.t~~n ;l.

Question 2. Let Ii' and 'j' be any two commodities which a consumer buys. If'
the Hicksian (or "compensated") demand function of a consumer is h(p, uo),
prove that fJhijfJPi ~ 0 and that fJhdfJpj = fJhj j8pi. '
You do not have to prove the Envelope 'J:'heorem here, but you do have to
prove all other results whi'ch you use.
"

, I,

II '

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::.
I

wkd.

i3

~,

s1!r 2..

xt, 1/.1 ~ -'" ~"6 .:. T1...

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B

.L

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~ .....
'/);.J{;...... f.-.t..

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e:t. . .)/Jlr.

is

s-kt 1's

= ,V;

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1ic "Jfut f." f :

WI

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10

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f)(C\rr\

.z004
C?tUC;

1'0(\

.i

Answer all of the following four questions.

[13 points] Let hi(P, uO) denote a consumer's Hicksian demand curve
for good i when the consumer faces prices P and enjoys utility level uO ,
Prove that
8hi 8h
_=_3
8pj

8pi

by using the definition of .the expenditure function and by 'using th~

Envelope Theorem.
I

A/1s~~ .f"Fihtje~, [~ .Tco~ Sr n i

CD

e Cf, LA} ";'

~V\.

L\

~"..,

I'-

;t;;

f' ~ s. t ~

r 1 ~ ~ (k -

(~ ) ~

.(JJ

(h~cJ)

200

Hf't!

rEXl1Yn

'1,,004
/A

t!) ')

.Av\'~ /M2r 1..

I'-

>wl-rk~e~v<1.

CbJ YOIJ~~ ~).

3. [11 points] Starting from the identity

where Xk is the Marshallian demand for good k and hk is the Hicksian

. demand for good k, determine the conditions under which

3)
dXk

r~'
,fad?:/L

- ap..e

4-

? ~ ~ \'

;;;.

'0 fj'

t. __~~_-Lt

- /t'"

J ~1-

e~ u/ k
jM,v/-n}: /5

G-I

X(

OX,

--1

dYh

x'
-x'I a.--L
J

~vn

dX('

= ;;(1

:;:!

dh-l

--

1- ;) x. {' .
x dM
L

jt <.-"

(avJ e

fi<.

fj"ls)J svbsJ,1vh ~

.f7~Z-

t:)(~yV\

l,",)q1qa-;{rOl1 1.-

Answer all of the following three questions.

1. Prove that a consumer's exp!'lnditure function e(p, u) is concave in p.
Fully explain your work.
.

Hint: .Here is the beginning and middle of a bare, unexplained proof

that a firm's cost function c(w,y) is concave inw:
TO'prove: c(twa+(l-t)Wb, y). 2:: tc(wa,y)+(l:"'t)C(Wb,y) for 0 ~ t~
1.
jIll ,

Proof:

c(twa+ (l-t)Wb, y) ~ min [twa + (l-t)Wb]X ..

.

xev(y)

min [twa X + (l~t)Wb . x]

xev(y)

> min twax+ min (l-t)WbX.

-:- xev(y)

xeV(y)

I II

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~

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I"V

+ (I-i) p~
~

.......

'd

s, {,

l.,{;t) = L.L

f..,. s.'~""J ~ 0 + (-I) =..

ls,t"'(1) 'iA].f,

1.

(t-t)~ f"!; [s.Ld~)=",]

.

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f)(qyV\

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e (or r~ tll-t) P.' IL)

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. I

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ttL
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Qu.e.1+t()V\ i- @
621.Section (must answer one) .
Question 1. Suppose a price-taking consumer buys n commodities q which,.,
are indexed by i, as in: Ql, q2, ... , qi, ... , qn'" Let the price of commodity i
be Pi. Let the'consumer's income be m. Let the consumer's budget share for
item i be
." Let
ij

What is this?
Let

8lnqi
= 81npj .

" 81nqi
'rJi = 8lnm'

What is this? "

a) Prove the so-called Cournot Aggregation Condition:
,

11111

,L

"

aj ji

-ai .

". j

,
I

As a hint: differentiate the budget constraint with r.espect to Pi.

b) Prove the so-called Engel Aggregation Condition:
Laj'iJj

=1.

As a hint: differentiate the budget constraint with respect to m.

I,

'I

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1.

(a) Prove that Hicksian demand curves h(p) u) are homogeneous of

degree zero in p.
.
(b) As some of you may already know) Euler proved the following: if
f(x) is differentiable and is homogeneous of degree k) then

\If(x) x

= kf(x).

(Do not forget that the left-hand side has a ". x in it.) What
property of Hicksian demand curves can you derive from this
result) given what you already know from part (a)?
( c) Rewrite your answer to part (b) for the special case when the
total number of commodities is exactly three.
(d) For any two commodities j and k) here are two definitions:
8hj(p) U)/8Pk ;:: 0

{:=;>

j and k are "substitutes))

<0

{:=;>

j and k are "complements.))

8hj(p) U)/8Pk

[B y the way) if instead of using the Hicksian demand curve hj (p) u)

on the left-hand side) we used Marshallian demand curves Xj(p) m)
where m is income) then we would use the terms "gross substitutes)) and "gross complements)) on the right-hand side (but this
is not important for this exam).]
Use the previous parts of this question) and other information)
to prove that if the total number of commodities is three) then
every good has at least one substitute;
(e) Prove that every good has at least one substitute (regardless of
what the total number of commodities may be).

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r ...

Short Section
.6710 Section (must answer one)
Question 1.. On p.147 of Varian's Microecon6mic Analysis, he writes:
We saw in our discussion of production theory that if a production
function was homogeneous of degree 1, then the cost function could
be writt'en.asc(w, y) = c(w) y. It follows from this observation
. that if the utility function is homogeneous of degree 1, then the
expenditure function can be written ase(p, u)=' e(p) u.
You may use this information (without proving that it is true) in the questions. below.
a) Prove that if the utility function is homogeneous of degree 1, then the
indirect utility function can be written as
v(p, m) .-: v(p) m.
.

I:

m=

lEntil You~ay ~se e(p,v(p,

m without proving it.
b) Prove that if the indirect utility function canl:>e written as v(p, rh) =
v(p) m, then the demand functions can be written as

-I.e., they are linear functions of income. Hint: You need not prove
Roy's Identity.
c) Prove that ifthe demand functions can be written as Xi(P, m) = Xi(p) m
-i.e., they are linear functions of income-then
I

8Xi(p, m) _ 8xj(p, m)
8pj

8Pi

Hint: If you use. the result that h = "Vp e here, then you snould prove
that h = "Vp e. If you use the Slutsky equation here, then you should
prove the Slutsky equation. If you usehi(p, u) = Xi(p, e(p, u here,
you donot need to prove it.

II

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(.'

An~wer

all of the following three questions.

1. If h(p, u) are the Hicksian demand curves for

'dp dh S O.

a consumer, prove that

Also:" very briefly discuss why this result, is or is not surprising.

Hint: use the analogue for, consumers of ShElphard's Lemma; find a
total differential. You do not have to prove Shephard's Lemma, nor,
do you have to prove the convexity or concavity of a function, although
if this were the qualifying exam then I would want you to prove these
things.

, I
I II

([).

~ (r,~) :::. ~ e{!~w.)

....

fhA-{pJ~ ~ S'~4nJf ~t!J-~ ~ ~'vJ+t~,

'

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= V; e(r/~) df

'. cl~(PIL1.)

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",

is.Jk

f-fL\ VV\

(~ Vp e(r~~)) d~.

,..,,..,

\ ~~ (p

AV15wtr i

II

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db ::

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'"

".

l' (4 ~4,

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= d P ~'. V;,e(f,u.) ,df ~ 0 ~t!. dr' .~~

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.
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..~~.

--

- -

-----

--

- --

_.

__.-

--_._----

------ --

---

2. [13 points] On August 22, 2010, the Los Angeles Times published an
opinion piece entitled Disincentivizing Greed written by Neal Grabler
(who was then a public policy scholar at the Woodrow Wilson Center in
Washington, DC). Here is an excerpt of the piece; it essentially argues
that decreasing tax rates increases the amount of dishonest labor, which
is an assertion about a comparative statics derivative.
To a surprising degree, economic misfortune has correlated with low top marginal tax rates. The top marginal tax
rate at the time of the 1929 crash was 24%. After his election,
Roosevelt promptly raised it to 63% and then to 94%, and
one could easily make the case that it was this rise, rather
than financial regulation, that played the primary. . . role in
curbing abuses by attacking greed at its source, without, by
the way, damaging the economy. Roosevelt essentially taxed
away big money.
During the long postwar economic boom, the top marginal rates hovered at 91%, removing a lot of the incentive to
game the financial system. There was no point in scheming
if you couldnt profit from it. Still, the country prospered.
So did Wall Street.
Then came the greed deluge. . . .[W]hen President Reagan
cut the top marginal tax rate drastically from 70% to 50% in
1981 and then to 28% in 1988 (putting aside for the moment
the cut in the capital gains tax and other investment incentives), thats when the troubles beganfrom the S&L crisis
right through to the fall of Lehman Bros. It wasnt enough
for the rich to be rich. Human nature being what it is, they
had to be super-rich. Or put another way, tax cuts, including
the Bush tax cuts, fed some of the worst aspects of human
nature and led to some of the worst excesses. It was just a
matter of time before Wall Street went wild.
When the fire of greed is stoked this way, financial reforms
cannot possibly bank it. . . .We now live in a country that
seems to worship wealth, and we may just have to live with
the consequencesa Bernie Madoff, an Enron, a Lehman
Bros., and a steep recession when the super-rich overplay
their hand. The alternative is regulation that goes to the
2

source by raising those marginal tax rates (and capital gains

taxes) and forcing the super-rich to merely be rich again. . . .
(a) Argue that a reasonable waycertainly not the only way, but a
reasonable wayto model the (indirect) utility that the rich or
super-rich people described in this article get from their pretax
income is

honest income + dishonest income .

(This is not a standard way of modeling indirect utility, of course.)
(b) If the tax rate is t, interpret

honest income + dishonest income

t (honest income + dishonest income) .
(c) Modelling income as a wage rate (consider an honest wage
and a dishonest wage) times a number of hours worked (consider honest labor time and dishonest labor time) and imposing some constraint on the number of hours humans work, discuss
whether or not the expression in part (b) supports Grablers hypothesis by calculating an appropriate comparative statics derivative. Does the appropriate second-order condition hold?
Hint: If you substitute the constraint on working hours into the
objective function, the new problem has only one endogenous variable, which is much easier to work with. You may ignore leisure
(and hence any leisure-labor tradeoff) in your answer.

Summer 2011 qualifying exam, Sec. 1 Qu. 2

te)

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<0

Section 1.
Answer all of the following three questions.
1. [12 points]
There is an old saying,
"Idle hands are the devil's workshop."
In other words, excessive idleness ("leisure") is a bad thing for people.
Suppose a price-taking consumer's utility depends on his purchases of
a good x 2 0 and his consumption ofleisure z (the notation "z" recalls
the sound at the beginning of the second syllable of "leisure").
(a) Argue that postulating a utility function of

is a reasonable way of modeling the idea that excessive idleness

is bad.
(b) Suppose the wage rate (that is, the payment for the opposite of
leisure) is w. Assume that all of the consumer's income comes
from selling his non-leisure time. Suppose the price of x is p.
What is the consumer's budget constraint?
(c) From the first-order conditions, argue that in order for the optimal x to be positive, the optimal z must be in [0,1).
(d) Find the optimal x and z explicitly in terms of exogenous variables.
(e) What does this consumer's labor supply curve look like?
(f) Check the second-order conditions for the optimization problem.
(g) What is this consumer's indirect utility function?

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5. [11 points] Suppose a consumer buys only two commodities, called x

and y, and suppose this consumer's preferences for x and yare strongly
monotonic. Suppose the government is contemplating giving (for free)
the consumer a certain amount more of commodity x. By drawing one
graph with x on the horizontal axis and y on the vertical axis, illustrate
the typical result that for this contemplated change, "willingness to
pay" is less than "willingness to accept." Also, describe how your .
graph would have to change in order to obtain the atypical result that
WTP is equal to WTA.

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1. [17 points] Using p to denote prices, m to denote income, e to denote

the expenditure function, and v to denote the indirect utility function,
consider the expression




e , v(p0 , m0 ) e , v(p0 , m0 ) ;
if the dot ( ) is replaced by p0 , this expression measures Equivalent Variation, and if it is replaced by p0 , it measures Compensating
Variation.
If a consumer buys two goods, a and b, at prices pa and pb , and has
utility function u = a b, then find the Compensating Variation (not
the Equivalent Variation) for this consumer.

Fall 2010, Final Exam, Qu. 1

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Section 2.
Answer two of the following three questions.
1. Attached to this exam is an excerpt from pages 167 and 168 of Varian's
textbook. This excerpt ends with Varian stating that

(a) If pO. < pI, is EVgreater than or less than CV?

(b) Related to compensating and equivalent variation are:
"willingness to pay" an amount of money In order to avoid
suffering the price increase from pO to pi i and
''willingness to accept" an amount of money in order to accept the price increase from pO to pl.
Is "willingness to pay" equal to CV or to EV? Is "willingness to
accept" equal to CV or to EV? Why?

'I,

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