Instructor' s Manual

\
to accompany
The Structure of Economics
A Mathematical Analysis
Third Edition
Eugene Silberberg
University ofWashington
Wing Suen
University of Hang Kong
glrwin
D McGraw-Hill
Boston nrr Ridge, IL Dnbnqne, lA Madison, WI New York San Francisco St. Lonis
angkok Bogobi Caracas Lisbon London Madrid
Mexico City Milan New Delhi Seonl Singapore Sydney Taipei Toronto
The third edition of The Structure of Economics contains two brand new chapters. Chapter 15,
Contracis and Incentives, and Chapter 16, Markets with Imperfect Information, cover the exciting
recent developments in information economics. Wing Suen ofthe University ofHong Kong wrote
these chapters. We discarded the old Chapter 19 on stability of equilibrium in order to accommodate
this new material. Also discarded is most ofthe old Chapter 2, the calculus review, which we feel is
no Ionger important. Wehave maintained, however, the discussion ofTaylor's series, and some
topics that are not typically covered in elementary calculus courses, such as continuous compounding.
The traditional chapters of the text contain many emendations and clarifications, which we hope will
prove useful. We discarded the very general primal-dual analysis bf statics presented as
Sec. 7.5 in the second edition, these results being of little practical use, in favor of greater analysis of
the more useful models where the parameters enter eilher the objective function or the constraint. We
have striven to keep the informal tone of the text in both the old and new chapters, and to focus on
deriving interestiflg and useful results, usmg the most elementary math that is required to do the job.
There is a tendency to treat comparative statics in a very terse manner, as though the whole subject
could be summarized by the solution to the matrix equation (H)(&!oa) = (-fxa). We, however, see
comparative statics as the core methodology of economic science. As long as economists are not able
to measure tastes and other important functions which determine behavior, the only scientific (i.e.,
refutable) propositions we can derive will be Statements about how decision variables change when
parameters change, under the assumption of stability of those underlying functions. Thus the third
edition to this text remains fiercely devoted to the goal of deriving refutable propositions from
maximization hypotheses, and understanding the mathematical structures !hat yield these results.
CHAPTER 1
2. Assertions are those postulates which we believe to be universally true, such
as "more is preferred to less,t' diminishing MRS, etc. Assumptions, on the other hand,
are the test conditions of a given expedment; they are true only at a given moment,
e.g., the price of gasoline rose 20 cents a gallon at a certain time, etc.
4. This question is answered in the introductory paragraph. Of course, economists would
Iove to be able to predict total quantities. This will be impossible as long as some
variables are not measured.
2
11. We will once again derive dx' J dt < 0. This can be seen by setting R( x) = 0 in Example
1. Thus this theory yields the same refutable propositions as those in Examples 1
through 3.
13. The side of the can uses 1r Dh; the "waste," made up of .the eightcorner pieces when a
circle is cut from two end squares, is k(2D
2
- J?-J') = lcD
2
(2- :: kD
2
a, where
a = 2 - and where 0 ::; k :5 1 the ability to recycle this material. The
objective function is thus
minimize
subject to
rrhD + 2D
2
- kD
2
a
rrD
2
h=l.
4
Using the constraint to eliminate h,
Therefore
minimize + D
2
(2 ;_ ka)
"D
41r
- rrD +2D(2- ka) = 0 or
- rrh + 2D(2- ka) = 0.
h 4-2ka 4-k(4-rr)
v= " = "
When k = 0 (no recycling), -jj = t; when k = 1 (no waste), -jj = 1.
CHAPTER4
Section 4.2
3. For 0 < a,< 1,a+< 1,
J
YLL = <>(<>- l)L"-2 KP < 0
YKK = ( -l)L"J(P-2 < 0
YLLYKK- YLK = a(l- a- )L2a-2K2P-2 > 0.
lf <> + = 1, the function is weakly concave.
4. YLL = -a/L
2
< 0; YKK = -/K
2
< 0, 0
YLK = UKL = ; YLLYkK = a/L
2
K
2
> 0.
Section 4.5
5.
"t = M Rt - M C - ty = 0
1r2=MR2-MC=O
where M R; = T R;'. Differentiating with respect to t,
(a)
( b)
8yj 8y2
"117ft+ "127ft = 1
where the "'i 's are given as in Problem 6, Section 4.2. This problern has the same
structure as the profit maximization problern with respect to a change in factor prices.
We find, similarly,
The denominator is positive here, but -1r
12
= C"(y) = MG' 0. If marginal cost is
rising, then 8yif8t > 0.
(c) This follows the profit-maximizing firm example exactly.
3
4
Additional Comment:
It is even the ease that {}y f8t = 8yjf8t + 8y2f8t does not have a determinate sign:
where D = 1<111<22- . - ~
2
> 0. Hence, only if the marginal revenue curve is downward sloping
in market 2 (a condition not implied by profit maximization) will total output sold by this
monopalist decrease in rcsponse to a tax increase. This result is known as the Edgeworth
taxation paradox.
6. Consider ditch-diggers and shovels. If the wage of ditch-diggers fall, holding the number
of shovels fixed will tend to reduce the firm's demand for ditch-diggers.
7. The model is now
maximize.- = TR
1
+ TR
2
- C(y)- ty
1
- ty
2
producing the first-order relations,
.-,=MRt-MC-t=O
.-
2
=MR2-MC-t=O.
Since the parameter t enters 6oth first-order relations, it will not be possible to sign
either 8yif8t or 8y2f8t. Letting D = 1<111<22- . - ~
2
,
(a) {}yfat= (.-11 +1<2z-2.-,2)/D<O, usingequation (4-8).
(b) If y
2
is held fixed, then this essentially becomes the one-variable monopalist of
Chapter 1; hence, ( 8yif8t)y, < 0.
8. Unless the revenue and cost functions can be measured, these two models are obser-
vationally equivalent. The parameter t enters both models identically; oyj I 8t < 0 is
implied in both models and no other results are forthcoming.
9. The objective function is
- - - - - ~ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
The first and second-order conditions are
.. , = pft - w, = 0,
", .. -pf" < 0
u- u '
1r2 = pfa- (1 + t)w2 = 0
D = p{!u/22 -1[2) > 0.
(c) Differentiating the first-order identities with respect to w
2
and t, ~ = -w
1
7f =
8='
W2f.?.:'
10. The objective function is
The model is essentially the sru:ne as the text problem; note, however, that the factor
demands are not homogeneaus of degree 1 in factor priees. There are no comparative
statics relations available for output price, since p is endogenous, being embedded in
11. This is an examination problem. It follows the earlier monopolistic discrimination
models. Note, however, in part (e), output price is endogenous. There is an implied
profit-maximizing output price. It makes no sense to ask about any other, non-implied
price.
12. The fundamental identity is
Differentiating with respect to p and then W2,
[)y' - [)y' [)y' 8:t2
---+--
[)p - op o : t ~ op
[)y' - [)y' 8:t2
aw2 = a.,g aw2
Using the second equation to eliminate oy' I a.,g from the first, and remembering that
oy' j8w
2
== -8:t2f8p.
[) [) ' ( ~ ) 2
.J!_ := .J!_ - _P_
ap - ilp ( ~ )
Since 8:t2jow2 < 0, oy' fop > oy' f8p.
5
6
CHAPTER5
Text
2. Expanding by the first column: lAI = auAu. Since Aa is also the determinant of an
upper-triangular matrix, the result follows by induction.
APPENDIX
2. Multiply (AB)-
1
AB =I by s-
1
A-
1
on the right.
4. Taking the transpese of AA-
1
= I, (A-
1
)' A' =I'= I. However, (A')-
1
A' =I by
definition. Since inverses are unique, (A-l)' = (A')-
1

5. Apply matrix multiplication.
8. This follows because AA' = I implies that A' A = I (taking the transpese of both sides).
CHAPTER 6
1. and 2. These problems are straightforward generalizations of the text material. In each
case, if c>; enters only the ;<h first-order relation, but not a constraint, then xi ja; =
- L;.; times the ratio of some border-preserving principal minor of H to the whole
Hessian determinant, H. These two determinants must have opposite sign, and thus
the result follows.
5. The equivalence of 4( c) and 4( d) is shown in Chapter 10 in the text.
6. The right-hand matrix for"' is (-1,0,0)'; for it is (0,-A,-x.)'. Thus, zjja =
-H
11
f H > 0. Since enters two first-order equations, no refutable propositions are
possible:
zj = -A H21 _ x
2
Hat
H H.
(b) Note that z';./a = -Ht./H = -H.tfH, A ja = -Hta/H = -H.tfH.
The result follows by substitution. When Chapter 7 has been covered, do this problern
again, using the duality results derived there.
8.
(b) Follows from second partials, AC;; = -AC/;;/f. Note that 8(-AC' f;)f8x; =
-;-AC'/;;- f;8AC' f8x; =-AC'/;; sii)ce 8AC' f8x; = 0.
(c) 8x,f8w, = (-/22 + x,ff(h2f,- !12!2))/AC(f"h2- ff
2
) ~ 0;8x,j8w, =
(/21 + x,ff(!Hh- f2,J,))/AC(!ld22- ff
2
) ~ 0; reverse .the ones and twos to
get ax,j8w2, 8x2/8w2.
(d) From first-order conditions, f; = w;/AC' = wd' /(w,xi+w2xi), multiply through
by x; and sum the two equations. This is not Euler's Theorem. This result, an
identify in w, and w2 (not x, and x
2
) holds only lft the point of miilimum AC,
not for all x,, x2.
CHAPTER 7
l(a) and (b). Fora, this follows the text exactly. Note that if x
1
and x 2 are held fixed, k
cannot be varied without violating the constraint.
(c) From the geometry in (a), rPa(a) = fa, and rPaa- !aa > 0. However,
rPa(a) E /a(xi(o:), xi(a),o:).
Differentiating both sides with respect to a,
from which the result fo!lows.
( d) The primal-dual problern is
subject to g(x
1
,x2) = k
7
_ i - ~ - - - - - - - - - - - - - - - - -
8
producing the Lagrangian
The first-order conditions are
c, = " - )..g, = 0
c2 = 12- )..u2 = o
Ca= Ja- <Pa= 0
c, = - < ~ > +).. = 0
C>. = k- g(z
1
,z2) = 0.
The third and fourth equations are the envelope theorem for <> and k. The second-order
matrix ts
c"
c12 J.a
0 -g,
c C2a ha
0
-g
H= f1a faa faa- <l>aa -<Pak 0
0 0 -</>ka <Pu
1
-g, -ga 0 1 0
The border-preserving principal minor formed by eliminating the first two rows and
columns,
faa- </>aa -<Pak 0
H11.22 = </>u 1 = -Uaa- <l>aa) > 0
1 0
yields the only implied curvature property for </>, <l>aa > !aa
(e) From <Pak= <l>ka, we have * = I!J:. Using d(1) and d(3),
from whieh the result follows by the implied differentiation.
(f) Of eourse, 8>.' f8k does not have an implied sign, unless f is eoneave and g is convex
in"'' and "'2
(g) lf /(:z:,, :z:2, 01) = h(:z:,, :z:2) + OI:Z:l, !aa E 0, thus from (a) or (d), tf>aa- 0 > 0.
2. This problern is a special case of problern 1, for the parameter 01. The reciprocity
condition in ( c) follows from
using the results of part b.
3. This problern is worked out in Cha.pter 8. It is a. useful exercise for students to do on
their own, however. Campare with the tr11-ditiona.l methodology of Cha.pter 6.
4. Long-Run
Short-Run:
s.t. w,:z:, + w2:z:2 = k
(a)
1t' = 7r' = L
81r' 81r' 8L 81r' 81r'
--=--=-----=--
aw, aw, aw, aw, aw,
= "''- >.:z:, = -:z:,(l + >.).
9
10
In long-run, .\ = 0 from first-order eonditions. Therefore, = -xi. In short-run,
,\ = l?h. - I = ill - I. Therefore,
Wt W2
ehr'
- = -xj(! + .\')
llw1
IJ2L llxi
-->-->----+--
llw( llw( . llw, llw1
>
[ll(xf(l + .\'))] >
0
llw
1
_ [ll(xl(l + .\'))] = -xj ( /).\')
. llw, llw1
_(I+.\') (llxf)
llw
1
"' + < 0
This doesn't imply < 0 sinee 0.
(b)
' I
;:.::J.. From the enve ope theorem,
8w,
Therefore, the elasticities cannot be compared.
(c) However, if it is assumed that < 0, since = '1rkw
1
== '1t':U
1
k = W, therefore,
h '
8
"'
8
"' ("'') ' ' h L Rd d'
ow, < 0; t ere.ore, < "' .....- < 0, or < t.e., t e - eman 1s
more elastic.
5. The first-<>rder conditions are
Multiplying through by xt and summing,
Integration yields
CHAPTER 8
I: /;x; a r</> a A' I: g;k; a A'rk
84>
</> =
8
k k, Thus
84> 8k
-r=T
log </> = log k +log a, or
</> = ak.
1. The technology available to the firm is just one constraint facing the firm; it says nothing
about how a firm uses that technology. In order to be well-defined, i.e., to be useful
in deriving testable implications, cost functions must consider additional behavioral
assumptions and constraints, such as wealth ma.ximization. With differing behavioral
postulates, different costs will be associated with a given output Ievel.
2. Empirical reasons suggest that the .cost-minimization model should yield an interior so-
lution, which in turn implies that the isoquants be postulated tobe convex to the origin.
Our observations refute the implications derived from the assumption of concave-to-
the-<>rigin isoquants. Such concave isoquants imply the firms will hire only one input.
This behavior is not observed. It is for this reason only that convex (to the origin)
isoquants are postulated.
11
12
5.
(a)
1r = max{maxfpy- w,x, - w
2
x
2
+ >.(f(x
1
, x2)- y)]}
y .Z:t ,::2
= max{py+ max[-w,x
1
- w
2
x
2
+ >.(f(x
1
,x
2
)- y)]}
y :l:l ,.t:.
(b) The inner minimum is precisely the cost minimization prob lern; the outer maximum
specifies that this occurs at the ;>rofit maximizing Ievel of output.
(c) The first order conditions of the Lagrangian are:
L,, = -w, + >.f
1
= 0
The matrix of the second derivatives of L is
0 0 0 -1
o Vu >.!12 !t
(L;;) =
-1 ,, !2 0
Its determinant, H, must be negative and its second-order border-preserving principle
minors, H;;, must be positive. Expanding H by the first column and then by the
remairring first row yields H = ->.
2
(/u/22- !(
2
) < 0. The comparative statics are
found using (L;;) and Cramer's Rule. In particular, the reciprocity condition falls out
directly:
The supply slope follows from the signs given by the second order conditions,
y = _ H
11
__ ( +) >
0
p H- (-) '
These results also follow immediately from the theorems of Chapter 7.
6. Salve the first order conditions of the Lagrangian
From the first two conditions
or
Substitute this into the constraint,
then
13
14
And x; can be found directly, by summetry. C' is found by substituting xi, x; into
= kt yll/( a, +a>)]+l
+ k
2
y[l/( a, +a,)] w\" /( a, +a,)Jw;[a, /(a, +a, )]+ 1
= ( kt + k
2
)yll/( a, +a,)lw\"/( a, a, +a,)}
where k; = (a;/ai)la;/(a;+a;ll. Now, differentiating C' with respect to, say, w
1
yields
Now, verify that
l
7.
(::) -1 = (::).
Therefore, (8C' jw!) = xj. Similarly, (8C' jw2) =: x;.
(b) Solve the first equation in part (a) for FLK Substitute into the second equation
for !KL (since hK = !KL)
(c) In part (a), !LL < 0 implies hK > 0.
(e) From equation (7-13), factor out,\ from each of the first two rows; then factor out
1/.\ from the last column and -1 from the last row.
CHAPTER.9
3. In each part, the cost function can be checked first tobe sure it makes sense, i.e., that
it is homogeneous of degree one in w,, w
2
Also, the production function which is found
can be verified by using it in the cost minimization problern and rederiving the original
cost function.
15
16
(a)
(b)
( c)
, 1 (W2) t >
Ct = x
1
= - - e>
2 W!
, 1 (w)-! !
C2 = x
2
= - - e .
2 W!
Rearrange x2 and substitute it into xj:
Substitute xj into x2: x2 = y +log(.\) or y = X2 + logx,.

c, = xj = yw, (wi + wn-!- = y (1 + ( ::)
2
).
Rearrange x2 and substitute it into xi:
4. By definition,
f(tx1, ... , txn-1 Xn) S t' f(x1, ... , Xn).
By Euler's theorem:
n
I:; /;x; = rj(x1, ... ,xn)
n-1
I:; /;x; = sf(x,, ... ,xn)
i=l
Subtracting the second summation from the first leaves,
fnxn = f(xt, ... , Xn)(r- s), or
(:;J Xn = y(r- s).
Rearrange this to solve the differential equation:
17
18
oy = (r _ s) (ox.)
Y Xn
J
oy = (r-s)J ox.
Y Xn
log y = (r- s) log Xn +log (g(x,, ... , Xn_
1
)),. or
r- ( )
y=xn g Xt, ... ,Xn-1
is the most general production function. If all x,'s have the same properties, the function
18
5. If y = f(x,, ... , :tn) = F(h(x,, ... , x.)) is homothetic, h can be homogeneous of degree
one in Zt, ... ,xn. If f is homothetic in x1, ... ,Xn-1 also, then h must be homogeneaus
of some degree s in x
1
, ... ,Xn-t Thus, using Eulers theorem as in question 9-4,
h must have the form hf'x2' ... x:;. Therefore, f(x
1
, ... ,xn) must have the form


... x!:").
7. If f = F(h(:c,,x2)), then fi = F'h, and fi; = F'h; + F"h,h;. Substitutethese into
equation (!t-28):

"= x,x,(f? fu- 2fthft2 + fl !22)
(F' h,)(F' h,)[F' h
1
x
1
+
= x,x,[(F'h,)2(F'hu + F"hD- 2(F'ht)(F'h,)(F'h
1
, +

.
. . . +(F'h
2
)
2
(F'h
22
+
Then, "= h,h,jh,,h when f is homothetic, since h is then homogeneaus of degreeone.
Intuitively, since for homothetic functions each isoquant is a radial blow-up of the
others, the properties of any one isoquant reflect the properties of all isoquants.
CHAPTER 10
2. Upward-sloping or flat indifference curves imply that the consumer may be "" better
off when both goods are increased.
4. >.M = (Uj fpt) = (U2fp,). Since x; arehomogeneaus of degree zero, Ut = U;(xj'f, xr)
is also homogeneaus of degree zero in PI, P2 and M. Then,
>.M(tp tp tM)-. U;'(tp, 'tp,, tM)
1' 21 - t
Pi
= c' Ut(p,, p,, M) .
P1
= t-1>,M(Pt,P2,M)
5. From the first-order conditions of the utility maximization model:
1
19
20
or
Substitute in Z2P2 = M- "'tPt from the constraint
then
And, by symmetry,
Now Substitute zf' xr into
il i .
(
M)a'
= <>t ~ <>2 Pt
(
M)a'
<>t ~ "'' p,
and into
Differentiate u with respect to M,
6. By Euler's Theorem for xf":
t (&;fl) Pi+ M = 0, i = l, ... ,n
J=l PJ .
I; (:!tr) (&xfl) + ( (&xfl) = 0
. X; &p
1
"; &M
J
L:eff+efL=O, i=l, ... ,n.
j
n &"1)1
LPi &!J = 1
;=t
" (x; M) &xtt
L.JPi -- --= 1
. Mx; &M
J
Differentiate the budget constraint with respect to p;:
n &xl)l M
LPiT+x; ::0, i=l, ... ,n
i=l p,
(10- 53)
(10- 54)
c:r) = -xfl (10- 59)
By Euler's Theorem for xY:
LKie.J1=-Ki
1
i=l, ... ,n.
j
21
Y1
I
22
9.
n ({) M)
2:P; ;'. = 0,
n=l p
1
'2::: (Pi) (oxf) = 0
. x, op
1
1
(10- 60)
'2::: ef; = 0, i = 1, ... , n.
j
Differentiate the constraint with respect to p;:
'tu;(
8
"'Y)=o, i=1, ... ,n.
i=l op,
Multiplylng by A,
LPi (axf) = o
j {)p,
2:Pi (P') ("i) (axf) =0 (10-61)
. M x
1
{)p,
1
:L: tc;ef. = 0, . i = 1, ... , n.
j
LPiSik = l:PjSkj = 0
i j
LPiSik + Pk'kk = 2:PjSkj + PkSH = 0
i# j#
LPiBik = LPiSkj =-p.csu.
i;tlr: j#k
Then, since su < 0,
2:PiSik = 2:PjBkj > 0.
i# #k
(10- 62)
23
11. This is just eq. (10-22).
12. This is an application of Roy's identity and eqs. (10-74) and (10-75) for the demand
curves with endowments.
13. L = U(o:1,o:2) + >.(1- Pl"l- p2o:2); The first-order conditions are:
L1 = U1 - >.p1 = 0
L2 = u2 - >.p2 = o
(a) Using the first-order conditions,
(
oU) M ( oU) M M M M M
0
"
1
"1 +
0
"
2
"2 = >. P1"1 + >. P2"2
= ,\M (PI"r + P2o:r)
= ,\M.
(b) By the envelope theorem,
(c):
(d) lf U(o:
1
,o:2) is homogeneaus of degree r, then by part (a),
However, using part (c), and then part (a),
:ll
I
\ ~
'
Ii
I.,
24
14.
-- Pt+ -- P2 '= ->.M = -rU*.
(
au) (au)
8p, 8p,
Thus U*(Pt
1
P2) is homogeneaus of degree -r by the converse of Euler's tbeorem.
= or U(zf!,zr)
= r'U*(Pt.P2)
Tbe first-order conditions are:
L, = U( - >.p, = 0
L2 ;", u ~ - >.p2 = o
Lp = M- PlZl -p2Z2 = o.
The second--order condition is
Uf'
D= 0 U!j -p2 > 0.
or,
v = -pw: -P W ~ > o.
Therefore,
u:' < 0, or u ~ < 0, or both.
(b) If U;' < 0, i=l,2,
25
(+)(-) > 0
(+) .
15. In the two-good model, the goods must be net substitutes, i.e., 8xlf f8pl > 0. From
the budget constraint (see the derivation of eq. (10-59)),
8xt'f 8xf M
PI-;;-+ P2-.- =-XI < 0.
VPI UPl
Since 8xt'f /P1 > 0, 8xf /8Pl < 0 is implied.
17.
subject to PlXl + ... + P"' = M.
The first-order conditions include
Therefore, A = xdp2 = x3/P
The budget constraint thus becomes
or
26
By symmetry,
Adding,
where K = [(2PIP2- p ~ ) + (2PaP4 - p ~ ) ] .
Also,
Note that &:x;f&p; 'f 0, i = 1,2; j = 3,4.
Lastly,
and &/" f&p; 'f 0, j = 3,4. Thus "two-stage" budgeting is not implied, even by
strongly separable homothetic utility functions.
27
19.
?'I
(a) This postulates that
8
<-g;[u,) > 0,
8
<-g;!u,) < 0. Using the quotient rule,
- [U.(8Utf8xt)- Ut(8U./8zt)]/U'f > 0
- [U.(8Utf8x)- Ut(au.;ax.)]/8Ul < o
or
Using the first-order conditions of the utility maximization problern on the second-
order condition:
Uu Uto -Pt Ua ul2
- ~
D= u.!
u . -p,
=
u.! u
- ~
-PI -pa 0
- ~ - ~
0
= l/>.
2
[Ut(UaUat- U1Uo2)- Uo(UaUu- UtUl2)]
28
which is positive, using the postulate.
(b) Assuming U1 U22 - U2U12 > 0, then using the first-order conditions:
then,
Assuming the opposite signs for [8(-U
1
/U2/8o:;] implies D < 0, i.e., concave to the
OJ:igin indifference curve8.
(c) The converse of part (b).
( d) [8( -U!/U2)/8o:2] > 0 implies [8( -U2/Ul)j8x2) < 0. Increasing consumption of >:2.
(o:
1
constant) will increase wealtb, thus the marginal evaluation of o:
2
relative to >:1 will
increase wben 0:2 is normal and >:1 is inferior.
(3) The postulate only asserts that the Ievel curves in two-dimensions are convex to the
origin. This may be true for all pa.irs of goods wbile the three-good indifference surfaces
are concave to the origin.
20. This problern utilizes the results of problern 19.
CHAPTER 11
1. Note th<>t
8>.M _ Dn+l,n+l _ (Ul'U; u::J
8M- D - D '
where >.M is the marginal utility of money income and Dis the usual bordered Hessian
determinant for the utility maximization model, except that the off-diagonal terms are
zero in the first n rows and columns. We have sign D = ( -1 )n by the second-order
conditions. The sign of the numerator term is ( -1 )n if all UJ' > 0; otherwise it is
(-1)n-l. Thus, if Uf' < 0, a11 i, then (J).M j(}M > 0; otherwise it is negative (at most
one UJ' > 0). Now note that
i = l, ... ,n (1)
from which the conclusions ab out the income effects follow. Note also
U
!' 8:1J; -- p, (}). .J.
, {) Jr'
8pJ Pi
(2)
Now
(3)
using eq. (10-22). Using this and the results for the income effects yields the results
for the pure substitution effects.
2.(a) This is a simple consequence of (1) and (2) above.
(b) Substitute (1) into (3).
3. If V(r!, ... , rn) = V1(r1) + ... + Vn(r;,), then clearly u;,Pi = Vr
1
r
1
= 0 when i :f: j.
From Roy's identity,
Thus for i :f: j :f: k,
29
30
and the result follows by division.
4. Using this result and (2),
and, (see eqs. (1G-63) and (10-64) this quickly implies unitary income elasticities and
homotheticity.
8. This is of course a revealed preference question. Leo is violating the weak axiom.
9. (a)
10 = p
1
z
1
;:: p
1
z
2
= 0, z
1
rev. pref x
2

8 = p2z2 < p2zl = 10
14 = p
3
z
3
< p
3
z
2
= 17
The preferences are also transitive so this is consistent with utility maxmization.
(b) 21 = p
2
z
2
;:: p
2
z
3
= 18, z
2
rev. pref z
3
, but 28 = P"z
3
< p
3
z
2
= 27is false. Therefore,
this is inconsistent with the weak axiom and therefore also inconsistent with utility
maximizati9n.
(
( c)
'
"
10.
23 = p
2
x
2
;<: p
2
x
1
= 22, x
2
rev. pref x
1
18 = p
1
x
1
< p
1
x
2
= 19
23 = p
2
x
2
;;: p
2
x
3
= 20, x
2
ref. pref x
3
17 = p
3
x
3
< p
3
x
2
= 20
31
Consistent
Since this set of purchase bundles is intransitive, and therefore inconsistent with utility
maximization (i.e., irrational), the answer is obvious.
32
11.
P2 M
Xt = -, X2 = - -1, P2 < M
Pt P2
PtXt + P2X2 P2 [ (:) -11
=p2+M-p2
=M.
The budget constraint is satisfied, and the demand functions are homogeneaus of degree
zero, so s
1
2 = s21 Thus, a utility function exists. Solve Xt, x2 for Pt = [ z,(!!"+l)] , P2 =
[ (z:!t)], and plug into:
Integrate:
=
1
=--
J 8x2 =- J a:,t + f(U)
"'2 = -log (xt) + f(U) or
U = g(x2 +log Xt)
12. Note that
[
P2M ] [ PtM ]
Pt"t + P
2
"'
2
= (Pt + P2) + (Pt + P2) E M
thus the budget equation is satisfied (as is homogeneity). Noting that
1
Jl
j
1
33
Pt"t P2
--=-
P2"2 Pt
we have
Integrating,
or
14. Let " be the good, Iet p
0
be some price at which the consumer. buys no " at all, and
p
1
the market price. We shall suppress the other prices. If the consumer is allowed
to purchase as much as he or she would like at price p
1
, utility U
1
is achieved. At
zero purchase of ", utility U
0
is achieved. The definitions of the first three r'neasures of
consumer's surplus are then:
1.
p'
- { "u dp
}po
p'
- { "u dp.
}p.
34
The integrals are all positive. Clearly, 2. > 1. always. If the good is normal, then since
ut > U
0
' .,f > .,yo and thus 3. > 2.
There are no unique monetary equivalents of the changes in utility in measures
4. and 5. except under special circumstances. If the indifference curves are vertically
parallel (see problern 15), then a given change in utility corresponds to a unique amount
of numeraire.
15. Inthis case we have n + 1 goods, x
0
,x
1
, ... ,xn, with prices 1 , p ~ . ... ,Pn The line
integral yielding the consumer's surpluses is
j 1 dxo + t p;(x)dx;.
i.=l
In order for this line integral to be path independent, ~ =
8
W_<:
1
= 0, since p
0
= 1.
The Pi(x)'s represent the marginal value of x
0
in terms of Xj(M RS;J) ~ = 0 means
that the slope of the indifference curves do not change as xo changes. With xo plotted
on the vertical axis and any "'i on the horizontal axis, this says the indifference curves
are vertically parallel, and hence ~ = 0, j = 1, ... , n.
CHAPTER 12
1.
(a)
(b)
In each case, "1+1 is a constant times o:;; if r > p, "1+
1
> o:;, i.e., consumption increases
over time since the premium for earlier availability exceeds the rate of impatience.
13
2. Initially, your consumption possibilities lie along AB. If the interest rate doubles, your
frontier pivots to AG; if half the complex burns, the frontier shifts to DG. Unless you
have no heirs and wish to consume your entire wealth immediately, you prefer the cause
to be a fall in the interest rate.
6. Suppose prices were to start doubling every year. Then depreciation would be seriously
understated, artificially increasing reported corporate profits and therefore corporate
taxes. The effects of the present rate of inflation are already capitalized into the price of
gold and depreciable assets. With greater than anticipated inflation, tbe relative price
of gold will increase. The capital gains exclusion for housing ameliorates this effect for
housing.
7. The text answer assumes constant nominal mortgage payments; with severe inflation,
we would expect to see indexed mortgages, alleviating this problem.
CHAPTER 14
3. The Kuhn-Tocker conditions are:
35