DPPE 0320

DEAM 0320
DMHE 0320
SECOND PUBLIC EXAMINATION
Honour School of Philosophy, Politics and Economics
Honour School of Economics and Management
Honour School of History and Economics
MATHEMATICAL METHODS
TRINITY TERM 2011
Thursday 9th June 2011, 09:30 - 12:30
Please start the answer to each question on a separate page.
There are 8 questions in this paper.
A nswer five questions.
Candidates may use their own calculators.
Do not turn over until told that you may do so.
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1. An individual with utility function u(y) has a coefficient of absolute prudence given
by -ulll(y)/u"(y), and a coefficient of relative prudence given by -yulll(y)/u"(y).
(a) Show that someone with the utility function u(y) = a + by + cexp( -Ay) has a
constant coefficient of absolute prudence A.
Given A > 0, what restrictions, if any, must be placed on the parameters a, b, c
to ensure that this is the utility function of a risk-averse utility maximiser?
(b) If someone has a constant coefficient of relative prudence R, what functional form
must their utility function have in general? (State dearly for what particular
values of R your derivation is not valid.)
Now given R > 1, what restrictions, if any, must be placed on parameters such as
a, b, c to ensure that this is the utility function of a risk-averse utility maximiser?
2. (I) Let sO be a continuously differentiable function defined on the real line with the
following properties:
s(O) = 0, Is(x)l:S; 1 V x, Is'(x)l:S; 1 V x
but s(x) and s'(x) do not exist. [sin(x) is such a function.]
Define the function f 0 on the real line by
f(x) = {
Show that fO is continuous at O.
Find the value of f'(O) from first principles.
if x # a
if x = a
Find an expression for f'(x) when x # O. What can be said about f'(x)?
Is fO differentiable everywhere? Is the derivative of fO continuous?
(II) Given any triangle, explain briefly why the longest side can be no longer than
half the perimeter.
Two numbers, p and q, are independently drawn at random from the continuous
uniform distribution on [0, 1].
Define x as min{p, q}, y as 1 - max{p, q}, and let z = 1 - x - y.
o min{p, q}
I
max{p, q}
I
1
x --_. _. ____ z -----y -
What is the probability that you can draw a triangle with sides of length x, y, z?
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3. Two agents work in a team and wish to maximise its payoff function
where b
2
i= 4, but they choose their actions independently.
(a) Suppose that the agents interact once and choose their actions simultaneously.
(i) Find the Nash equilibrium of the game.
(ii) Determine whether the Nash equilibrium choices of Xl and X2 maximise V by
examining its Hessian.
(b) Suppose instead that the agents interact continuously and adjust their actions
according to the differential equations
. 8V
XI=-
(!xl
(i) Find the general solution to this system in terms of the values of Xl and X2
at time O.
(ii) Describe the long-run behaviour of Xl and X2
4. (a) Suppose that the random variable X has the density function
()
"+1 IX_
f X - x
{
a 'f > 1
- 0 otherwise'
where a > O.
(i) Verify that f is a density function.
(ii) Find the moments E(xr), specifying for which values of r they exist.
(iii) Find the expected value of X given that X is greater than k (with k > 1) if
0'>1.
(b) Suppose that X and Y have the joint density function
{
a(a+1)
f(x, y) = l)"+2

otherwise
(i) Find the marginal distributions of X and Y.
(ii) Are X and Y independent?
(iii) Find the conditional density of X given Y = y and show that
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E(XI Y = y) = 1 + for Go> 1.
Verify that E(X) = E(E(XI Y)).
3 turn over
5. (I) You have been asked to design a solid cylinder of a given volume v, by specifying
the height h and the diameter of the circular cross-section d.
(a) If your aim is to minimise the surface area of the cylinder, what should you
choose for d in terms of h?
(b) What if your aim is to maximise the surface area?
[The volume of a cylinder is the height x the area of the circular cross-section;
the surface area is the height x the circumference of the circular cross-section +
the area of the two circular faces.]
(II) Find the general solution of the second-order linear difference equation
3YH2 = 7Yt+1 - 2Yt, t = 0, 1, ...
What is the steady state? Is it stable?
Now assume that Yo = 1 and Yl = k. What is
and how does it depend on k?
I
YHI
Im--
t-HXJ Yt
For what values of k, if any, does Yt converge to the steady state?
6. Two firms are trying to invent a new product. Firm A has probability of success p
each month and firm B probability q, in both cases independent of the outcomes in
other months and of the outcome of the other firm's efforts. Let X be the number
of months it takes firm A to succeed and Y the number of months it takes firm B to
succeed.
(a) Explain why X has a geometric distribution, with Pr(X = r) = p(l - py-l for
r = 1,2, ....
(b) Find Pr(X :::: k) for any k :::: l.
(c) Find the probability generating function of X.
(d) Find E(X).
(e) Find the probability that it takes A at least as long as B to succeed.
(f) Let Z = min{X, Y} be the time it takes for at least one firm to succeed. Find
Pr(Z:::: k) for any k, and hence show that Z also has a geometric distribution.
(g) Suppose that the first time either firm succeeds is month n. What is the proba-
bility that it is A that succeeds in month n?
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7. (a) Suppose f : Rn ---t R is a concave function. Show that for any a E R the set
S = {x : f(x) a} is convex.
(b) A consumer has utility function U(Xb X2) = -xII - xiI, where the quantities Xl
and X2 must be non-negative. Denote the prices of goods 1 and 2 by PI > 0 and
P2 > O. She wishes to choose Xl and X2 to minimise the cost of obtaining utility
at least u. Let e(p,u) be the minimised cost, where p = (PI,P2).
(i) Explain whether the Kuhn-Tucker first-order conditions for the consumer's
problem are (a) necessary, and ((3) sufficient for optimality.
(ii) Find the optimal choices of Xl and X2 and e(p, u).
(iii) Show that e(p, u) is homogeneous of a certain degree in p, which you should
specify.
(iv) State Euler's theorem for homogeneous functions and verify that it holds for e
as a function of p. Give this result an economic interpretation.
8. (a) For what values of a do the vectors
G), (D, G)
span R3?
(b) In a certain economy there are two possible states. Asset A sells for 7 per unit
and each unit pays out 2 in state 1 and 3 in state 2. Asset B sells for 4 per
unit and each unit pays out 1 in state 1 and 2 in state 2. If a unit of asset C
pays out 1 in each state, at what price must it sell if there is to be no arbitrage?
(c) In a certain country there are two goods, 1 and 2. To produce one unit of good
1 requires 0.1 units of good 1, 0.2 units of good 2 and 0.6 units of labour. To
produce one unit of good 2 requires 0.8 units of good 1, 0.1 units of good 2 and
0.3 units of labour. If it is desired to produce 130 units of each good, how much
labour is required in total?
(d) In the country in the previous part, capitalists require a return of r 0 on the
cost of non-labour inputs so prices satisfy the equations
PI = (1 + r) (O.IPI + 0.2p2) + 0.6w
P2 = (1 + r) (0.8pI + 0.lp2) + 0.3w
What values can r take?
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