02 EC487 Sol Sample Exam
02 EC487 Sol Sample Exam
02 EC487 Sol Sample Exam
(i) State the Weak Axiom of Revealed Preference (WARP). WARP states
that for each A, B ∈ A, x, y ∈ A ∩ B, x ∈ c(A), y ∈ c(B) implies that
x ∈ c(B).
(ii) Prove or disprove that WARP implies E. Assume x ∈ c(A)∩c(B) and
let z ∈ c(A ∪ B), which implies that z ∈ A or z ∈ B. Wlog assume
z ∈ A. Then x, z ∈ A ∩ (A ∪ B). Since x ∈ c(A), z ∈ c(A ∪ B), WARP
implies x ∈ c(A ∪ B) as desired.
(iii) Prove or disprove that E implies WARP. It does not.
Let A = {{x, y, z}, {w, x, y}}, which c({x, y, z}) = {x} and
c({w, x, y}) = {w}. This satisfies E but violates WARP.
1
2. Sketch of the answers:
∂c
= β α w1α−1 w21−α y = x1 (w1 , w2 , y),
∂w1
∂c
= β (1 − α) w1α w2−α y = x2 (w1 , w2 , y).
∂w2
Solving for w2 /w1 we obtain:
1
1−α − α1
x1 x2
= .
βαy β (1 − α) y
y = κ xα1 x21−α ,
where
1
κ= .
β αα (1 − α)1−α
(iii) The aggregate supply function for commodity y in this market is:
p∗ = β w1α w21−α
2
(iv) The Marshallian demand for each individual consumer is the solu-
tion to the following problem:
Y ∗ = 100.
p∗ = β w1α w21−α
Y ∗ = 100.
3
3. The economy can be described in the Edgeworth box represented below.
B
...
...
...
...
...
... UB
...
...
...
...
...
x1 ...r
...
...
ω ...
... o2
...
...
A ...
U ...
...
o1 ...
...
..r
A x2 E
max xA
2
xA A
1 ,x2
(1)
x̄1 x̄2
s.t. p xA A
1 + x2 ≤ p +
2 2
max xB
1
xB B
1 ,x2
(2)
x̄1 x̄2
s.t. p xB
1 + xB
2 ≤p +
2 2
4
and it is also represented in the same Edgeworth box above.
(ii) The Walrasian equilibrium is denoted by E. The equilibrium alloca-
tion is: xA A B B
1 = 0, x2 = x̄2 , x1 = x̄1 and x2 = 0. The equilibrium
relative price is p∗ = 1.
(iii) The unique Pareto-efficient allocations is xA A B
1 = 0 x2 = x̄2 , x1 = x̄1
and xB
2 = 0. This allocation corresponds to point E in the graph
above. Therefore the Walrasian equilibrium allocation in (ii) above is
Pareto efficient.
5
4. Sketch of the answers:
6
• Play C in period 1.
• If in period 1 the outcome of the game is (M, C) play L in period
2.
• If in period 1 the outcome of the game is different from (M, C)
then in period 2 play the non-degenerate mixed strategy Nash
equilibrium of game where player 2 randomizes with probability
1
2
on action L, with probability 0 on action C and with probability
1
2
on action R.
Notice that it is subgame perfect to punish deviations in period 2
since in the second period whatever the history of the game the
players play a mixed strategy Nash equilibrium of the stage game.
Moreover the strategies above are Subgame Perfect for both players
if and only if:
1−δ 1−δ
(5 + δ 4) ≥ (6 + δ 2)
1 − δ2 1 − δ2
or
1
δ≥ . (3)
2