Microeconomics

2017

Problem 1:

a. 𝐿𝑒𝑡 𝑿 = (𝑥1 , 𝑥2 ), 𝒀 = (𝑦1 , 𝑦2 ) 𝑎𝑛𝑑 𝒁 = (𝑧1 , 𝑧2 )

𝑠𝑢𝑐ℎ 𝑡ℎ𝑎𝑡 𝑿 ≻ 𝐘 ∴ U(X) > U(Y)
This can occur when 𝑥1 > 𝑦1 (1)
OR when 𝑥1 = 𝑦1 𝑎𝑛𝑑 𝑥2 > 𝑦2 (2)

when lexicographic preferences apply.

Additionally, 𝒀 ≻ 𝐙 ∴ 𝑈(𝑌) > 𝑈(𝑍)

This can occur when 𝑦1 > 𝑧1 (3)

OR when 𝑦1 = 𝑧1 𝑎𝑛𝑑 𝑦2 > 𝑧2 (4)

when lexicographic preferences apply.

Under situation (1)𝑥1 > 𝑦1 :

𝑥1 > 𝑦1 ⇒ 𝑥1 > 𝑧1 due to the transitive properties of real numbers, since we know from (3)
and (4) that 𝑧1 ≤ 𝑦1
.∴ 𝑋 ≻ Z

Under situation (2): 𝑥1 = 𝑦2 𝑎𝑛𝑑 𝑥2 > 𝑦2

So when 𝑦1 > 𝑧1 , ∴ 𝑥1 = 𝑦1 > 𝑧1 by the transitive properties or real numbers.
So 𝑿 ≻ 𝒁

Now when 𝑦1 = 𝑧1 𝑎𝑛𝑑 𝑦2 > 𝑧2 . Now 𝑥1 = 𝑦1 = 𝑧1 𝑎𝑛𝑑 𝑥2 > 𝑦2 > 𝑧2 ⇒ 𝑥2 > 𝑧2 due to the
transitive properties of real numbers.
.𝑿 ≻ 𝒁

Thus in each possible situation, if 𝑿 ≻ 𝐘 and 𝒀 ≻ 𝐙, then 𝑿 ≻ 𝒁

b. If two bundles X and Y are such that bundle X contains at least as much of each good as
bundle Y, and strictly more of at least one good, then an individual prefers X to Y (𝑿 ≻ 𝐘).

𝐿𝑒𝑡 𝑿 = (𝑥1 , 𝑥2 ), 𝒀 = (𝑦1 , 𝑦2 ) 𝑤ℎ𝑒𝑟𝑒 𝑥1 > 𝑦1 𝑎𝑛𝑑 𝑥2 > 𝑦2

Given bundle X has more of good 1 than bundle Y, under lexicographic preferences, 𝑿 ≻ 𝒀
 Further, given that bundle X also has more of good 2 than bundle Y, 𝑿 ≻ 𝒀 under strict
monotonicity. Therefore strict monotonicity holds under lexicographic preferences.

Problem 2:

a. Strict monotonicity: if bundle X has more of each good than bundle Y ⇒ 𝑿 ≻ 𝒀

𝐿𝑒𝑡 𝑿 = (1.1, 1.1) → ⌊𝑥1 + 𝑥2 ⌋ = ⌊1.1 + 1.1⌋ = ⌊2.2⌋ = 2
& 𝒀 = (1, 1) → ⌊𝑦1 + 𝑦2 ⌋ = ⌊1 + 1⌋ = ⌊2⌋ = 2
Since 𝑥1 > 𝑦1 𝑎𝑛𝑑 𝑥2 > 𝑦2 , 𝑠𝑡𝑟𝑖𝑐𝑡 𝑚𝑜𝑛𝑜𝑡𝑜𝑛𝑖𝑐𝑖𝑡𝑦 𝑠𝑎𝑦𝑠 𝑡ℎ𝑎𝑡 𝑿 ≻ 𝒀
However, the floor function says that U(X) = U(Y) = 2
.∴ 𝑿 ~ 𝒀 𝑎𝑛𝑑 ∴ The floor function breaks the assumption of monotonicity by proof by
contradiction.
b. Continuity: for any two bundles 𝑿 ≫ 0 𝑎𝑛𝑑 𝒀, there exists a non-nonnegative real
number a such that 𝑎 ⋅ 𝑿~𝒀 𝑤ℎ𝑒𝑟𝑒 𝑎 ⋅ 𝑿 is defined as the multiplication of every good
on bundle X by a.
Take 𝑿 = (𝑥1 , 𝑥2 ) 𝑎𝑛𝑑 𝒀 = (𝑦1 , 𝑦2 ), 𝑤ℎ𝑒𝑟𝑒 𝑥1 , 𝑥2 , 𝑦1 , 𝑦2 ≥ 0
We require a such that 𝑎 ⋅ 𝑈(𝑿) = 𝑎 ⋅ ⌊𝑥1 , 𝑥2 ⌋ = ⌊𝑦1 + 𝑦2 ⌋ = 𝑈(𝒀)
⌊𝑦1 + 𝑦2 ⌋ 𝑈(𝒀)
∴𝑎= =
⌊𝑥1 , 𝑥2 ⌋ 𝑈(𝑿)
⌊𝑦1 + 𝑦2 ⌋
∴ 𝑎 ⋅ 𝑈(𝑿) = ⋅ ⌊𝑥1 , 𝑥2 ⌋ = ⌊𝑦1 + 𝑦2 ⌋ = 𝑈(𝒀)
⌊𝑥1 , 𝑥2 ⌋
∴ ∃𝑎 such that a𝐗 ~ 𝐘and therefore these preferences satisfies continuity.
c. The proof states that it is not possible that u(X) = ax and u(x)=bx such that 𝑎𝑥 ≠ 𝑏𝑥 .
Step ONE of the proof supposes that 𝑎𝑥 ≠ 𝑏𝑥 and 𝑎𝑥 > 𝑏𝑥
and ∴ 𝑖𝑓 𝑎𝑥 > 𝑏𝑥 , 𝑎𝑥 𝒆 ≻ 𝑏𝑥 𝒆
However, when monotonicity does not hold as show in part a. we can only
determine that if 𝑎𝑥 > 𝑏𝑥 ⇒ 𝑎𝑥 𝒆 ≻ 𝑏𝑥 𝒆 𝑜𝑟 𝑎𝑥 𝒆~𝑏𝑥 𝒆
If we use the above example and let 𝑎𝑥 = 1.1 𝑎𝑛𝑑 𝑏𝑥 = 1: 𝑈(𝑎𝑥 𝒆) = ⌊1.1(1) +
1.1(1)⌋
= 2 = ⌊1(1) + 1(1)⌋ = 𝑈(𝑏𝑥 𝒆). ∴ 𝑿~𝒀
But if we let 𝑎𝑥 = 1.5 𝑎𝑛𝑑 𝑏𝑥 = 1: 𝑈(𝑎𝑥 𝒆) = ⌊1.5(1) + 1.5(1)⌋
= 3 ≠ ⌊1(1) + 1(1)⌋ = 2 = 𝑈(𝑏𝑥 𝒆). ∴ 𝑿 ≻ 𝒀
In step TWO on slide 19 of topic 1, it says:
By definition of u(X), 𝑿~𝑎𝑥 ⋅ 𝒆 𝑎𝑛𝑑 𝑎𝑡 𝑡ℎ𝑒 𝑠𝑎𝑚𝑒 𝑡𝑖𝑚𝑒, 𝑿~𝑏𝑥 ⋅ 𝒆. Then by
transitivity, 𝑎𝑥 ⋅ 𝒆 ~ 𝑏𝑥 𝒆
The proof then states that steps ONE and TWO contradict which is impossible as the
foot note reads “it is as if two real numbers satisfied x>y and x=y at the same time.”
However, the proof relies on monotonicity which is not satisfied by the floor
function as shown in part a. and therefore we cannot prove the existence of a utility
function using the slides on topic 1.
 0, 0 ≤ 𝑥1 + 𝑥2 < 1
1, 1 ≤ 𝑥1 + 𝑥2 < 2
2, 2 ≤ 𝑥1 + 𝑥2 < 3
d. 𝑈(𝑿) = ∙ ∙
∙
∙
{ 𝑛, 𝑛 ≤ 𝑥1 + 𝑥2 < 𝑛 + 1
The above example represents the floor function

Problem 3:

a. We have 𝛿 > 0 which is specific to an individual and fixed for an individual across different
situations. As well as 𝑥 𝑒 which has no restriction to certain individuals or situations.
𝑈 𝐿𝐿 = 𝑥 − 𝛿(𝑥 − 𝑥 𝑒 )2
𝑑𝑈 𝐿𝐿
∴ = 1 − 2 ⋅ 𝛿(𝑥 − 𝑥 𝑒 )
𝑑𝑥
Now let this derivative = 0 to find optimal x: 1 − 2 ⋅ 𝛿(𝑥 − 𝑥 𝑒 ) = 0
1
𝑆𝑜, 𝑥 ∗ = + 𝑥𝑒
2𝛿
Now since optimal x* is dependent on only the two parameters described above, and 𝑥 𝑒 is
unrestricted (with the exception of ensuring x remains within the total money domain), it is
NOT possible to find data inconsistent with LL preferences. So, no matter the m value
chosen, an unrestricted 𝑥 𝑒 chosen so that it is explanatory.

b. NOW, 𝛿 is the same as in part a. but 𝑥 𝑒 is now restricted to apply to all individuals across
the same situation but can vary from situation to situation. In other words, all individuals
face the same expectation parameter.
1
The equation for 𝑥 ∗ = 2𝛿 + 𝑥 𝑒 remains the same.

Now say we choose m=9 to form our data. And of the participants involved, there is an even
distribution of x* values. This implies that given 𝑥 𝑒 is a constant as this is ONE situation, the
delta value for individuals of different chosen x* values must be different.

X* % of population
0 10
1 10
2 10
3 10
4 10
5 10
6 10
7 10
8 10
9 10
So each group of x*, they must have a different delta to the other groups

Now suppose we are in a new situation where m=10 and here all of our data shows that of all the
data collected from participants, now all participants choose the same x* value = 3.

X* % of population
0 0
1 0
2 0
3 100
4 0
5 0
6 0
7 0
8 0
9 0
10 0

Here our data is inconsistent with LL preferences. Since our 𝑥 𝑒 is constant for all participants, the
delta must be equal for each individual now. This contradicts the previous data where each
individual had unique delta and here there is no unique delta. If LL preferences were consistent, it
would require individuals to change their delta from 1 situation to another.