Prof.

Ignacio Monzón
Collegio Carlo Alberto
Fall 2018

M ICROECONOMIC T HEORY - PS #5
Due date: 12 Nov 2018

1. Let there be I consumers in an economy. Aggregate demand in this economy is

denoted by x ( p, w1 , . . . , w I ) = ∑iI=1 x ( p, wi ). In period 0, prices where given by
vector p and the distribution of wealth was given by (w1 , . . . , w I ), with w = ∑iI=1 wi .
In period 1, prices are given by vector p0 and the distribution of wealth
is given by
0 0 0 I 0 0 0
(w1 , . . . , w I ), with w = ∑i=1 wi . Show that if vi ( p, wi ) ≥ vi p , wi for all i then
w0 ≤ p0 x ( p, w1 , . . . , w I ).

2. Preferences for individuals A and B can be represented as u A ( x A , y A ) = x αAA y1A−α A

and u B ( x B , y B ) = x αBB y1B−αB , with 0 < αi < 1 for i ∈ { A, B}.

(a) Provide an example for the preferences described above such that aggregate
demand cannot be written as a function of aggregate wealth.
(b) Restrict the utility functions of individuals A and B so that aggregate demand
can be written as a function of aggregate wealth. In other words, show that
under your restrictions x ( p, w) = ∑i= A,B xi ( p, wi ) for all (w A , w B ) with w A +
w B = w.
(c) Individual demand xi ( p, wi ) satisfies the uncompensated law of demand
(ULD) if:
p0 − p xi p0 , wi − xi ( p, wi ) ≤ 0




for any p0 , p and wi , with strict inequality if xi ( p0 , wi ) 6= xi ( p, wi ).

Show that ULD holds for A and B.
(d) Show that if the wealth distribution rule is wi = β i w, then ULD also holds for
the aggregate demand (for all values of α A and α B ).
(e) If the wealth distribution rule is wi = β i w, then WARP holds for the aggregate
demand.
Provide an example (with the preferences specified above) so that WARP does
not hold. (You have to assume a different wealth distribution rule)

1
3. Varian 1.10. Let Y be a production set. We say the technology is additive if y ∈ Y
and y0 ∈ Y implies y + y0 ∈ Y. We say the technology is divisible if y ∈ Y and
0 ≤ t ≤ 1 implies ty ∈ Y. Show that if a technology is both additive and divisible,
then Y must be convex and exhibits constant returns to scale.

4. Varian 3.2. (modified and enlarged version). An output y is produced using only one
input x. The price of the output is p, while the price of the input is normalized to
w = 1. The production function is given by:
(
0 if x ≤ 1
f (x) =
ln( x ) if x > 1

(a) Find the profit function.

(b) Graph the technology set Y. To do so, have x in the x-axis and y in the y-axis.
Negative numbers indicate inputs.
Y is convex if for all y, y0 ∈ Y and all α ∈ [0, 1], αy + (1 − α)y ∈ Y.
Y satisfies non-increasing returns to scale if for any y ∈ Y, and α ∈ [0, 1], αy ∈ Y.
Y satisfies non-decreasing returns to scale if for any y ∈ Y, and α > 1, αy ∈ Y.
Y satisfies additivity if for all y, y0 ∈ Y, y + y0 ∈ Y.
(c) Is Y convex? Does it satisfy non-increasing returns to scale? Does it satisfy
non-decreasing returns to scale? Does it satisfy additivity? Justify.

5. Varian 4.6. (modified version). A firm has two plants. The production function in the
first plant is f 1 (l1 ) = (l1 /4)2 , whereas the production function in the second one is
f 2 (l2 ) = (l2 /2)2 . The price of the output is p, while the price of the input (labor) is
normalized to w = 1.

(a) Let y1 and y2 denote the quantities produced in plants 1 and 2 respectively.
Graph the technology sets Y1 and Y2 , one for each plant. To do so, have l1 (or
l2 ) in the x-axis and y1 (or y2 ) in the y-axis. Negative numbers indicate inputs.
(b) Find the cost functions ci (yi ) for each plant i = 1, 2.
(c) A firm owns both plants. Find the cost function c(y) for the firm.