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402 Assignment 1

This document outlines two assignment questions for an economics course. [1] The first question asks students to define homogeneous and homothetic functions, discuss their implications for demand functions and income elasticity, explain Euler's Theorem, and apply it to show zero profits for a firm with constant returns to scale. [2] The second question poses a utility maximization problem for Myrtle and asks students to derive demand functions, verify optimality, find the indirect utility and expenditure functions, reformulate the problem as a cost minimization, find optimal values, and show equivalence to the expenditure function.

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zamir
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94 views

402 Assignment 1

This document outlines two assignment questions for an economics course. [1] The first question asks students to define homogeneous and homothetic functions, discuss their implications for demand functions and income elasticity, explain Euler's Theorem, and apply it to show zero profits for a firm with constant returns to scale. [2] The second question poses a utility maximization problem for Myrtle and asks students to derive demand functions, verify optimality, find the indirect utility and expenditure functions, reformulate the problem as a cost minimization, find optimal values, and show equivalence to the expenditure function.

Uploaded by

zamir
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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ECON 402 Summer 2006

Assignment 1: due Tuesday May 21

1. You are to use Silberberg/Suen (or any other source) as a reference to help you answer and explain
the following. To answer these questions it will take a combination of research and clever reasoning.

(a) What are homogeneous and homothetic functions? What properties do they share in common?
How do they differ? When would an economist prefer one over the other when building an
economic model?
(b) Based on your answer to (a), consider the implications for individual demand functions derived
from a homogeneous utility function in a two good world; specifically:
1. What does it imply about income elasticity of demand for each good?
2. Why is it that the demand functions from this type of utility function can never be linear?
(c) What is Euler’s Theorem?
(d) Suppose a perfectly competitive, profit maximizing firm has only two inputs, capital and labour.
The firm can buy as many units of capital and labour as it wants at constant factor prices r and
w respectively; i.e.
π = pf (K, L) − wL − rK
If the firm’s production function has constant returns to scale, use Euler’s theorem
to show that in long-run equilibrium the firm earns zero profits.
(hint: look at the first order conditions for profit maximization)

2. Myrtle has the following maximization problem

Max u = x1/3 y 2/3 subject to B = px x + p y y

where x and y are quantities of two consumption goods whose prices are px and py respectively. Myrtle
has a budget of B.

(a) From the first order conditions find expressions for the demand functions x∗ = x(px , py , B),
y ∗ = y(px , py , B)
(b) Verify that Myrtle is at a maximum by checking the second order conditions.
(c) By substituting your solutions into the utility function, find an expression for the indirect utility
function, u∗ = u∗ (px , py , B). Re-arrange the indirect utility function to find an expression for the
Expenditure Function,B ∗ = B ∗ (px , py , u∗ )
Myrtle’s problem could be recast as the following:

M inimize px x + py y s.t. u0 = x1/3 y 2/3

where U0 is equivalent to the maximum utility obtained from the above problem
(d) Find the values of x and y that solve this minimization problem.
(e) Check the second order conditions to verify you have a minimum
∂B(px ,py ,U0 )
(f) Show that your solution to x from the minimization problem is equal to ∂px from part
(c).

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