National University of Singapore

Department of Economics

EC2101 Microeconomic Analysis I

Semester 1 AY 2016/2017

Homework 2
Exchange and Cost Minimization
Due date: 27 Oct 1 pm
Question 1 In an exchange economy, consumer A has utility function
( y A )2
A
A
A
U (x , y ) = x
and consumer B has utility function U (x B , y B ) = x B + 2 y B .
4
A is endowed with is 0 unit of x and 8 units of y and B is endowed with 16 units of x
and 8 units of y.
a) Is the endowment allocation Pareto efficient? If yes, why? If not, suggest a Pareto
improvement over the endowment allocation.
b) Is the allocation (xA=4, yA=0, xB=12, yB=16) Pareto efficient? If yes, why? If not,
suggest a Pareto improvement over this allocation.
c) Draw an Edgeworth box with x on the horizontal axis and y on the vertical axis.
Measure goods for consumer A by the distance from the lower left corner of the box.
Draw the contract curve in your graph. Label your graph clearly. (No calculation or
explanation is needed.)
d) Set y as a numeraire. Find the equilibrium price of x and the equilibrium allocation.
For simplicity, assume the equilibrium allocation is a tangency point between the
budget line and consumer Bs indifference curve.
Question 2 There are two consumers, A and B, in an exchange economy. There are
three goods in the economy, x1, x2, and x3.
a) Prove the Walras law in this two-consumers, three-goods economy.
b) When market for good 1 is in equilibrium, market for good 2 and market for good
3 must also be in equilibrium. Is the above statement true or false? Briefly explain.
c) If there is excess demand for good 1, there must be excess supply for some other
good. Is the above statement true or false? Briefly explain.
Question 3 A firms production function is Q = min(3L,5K ) . The price of labor is
w > 0 and the price of capital is r > 0 .
a) In the long run, when labor becomes more expensive, holding the price of capital
and the output level constant, how does the cost-minimizing choice of labor change?
Briefly explain.
b) Derive the long-run total cost function. Draw the long-run expansion path. Label
your graph clearly.

National University of Singapore

Department of Economics

EC2101 Microeconomic Analysis I

Semester 1 AY 2016/2017

c) Suppose capital is fixed at K = 2 in the short run. Derive the short-run total cost
function. At what output level is K = 2 a cost-minimizing choice of capital in the
long run?
Question 4 A firms production function is given by Q = KL K 2 + 4K . The price of
labor is w > 0 and the price of capital is r > 0 .
a) Consider the isoquant Q = 9 . Is there an uneconomic region of production? If yes,
in the uneconomic region, which one is negative, MPL or MPK ?
b) Assuming the firm uses both labor and capital, derive the long-run total cost
function. (Hint: solve for the demand of capital first.)
c) Continue to assume that the firm uses both labor and capital, show that the long-run
total cost of production is increasing in r.