Some solutions for Exercise 5-6, 2006

Mathematics for Economics and Finance

Prof: Norman Schürho¤
TAs: Zhihua Chen (Cissy), Natalia Guseva

Exercise Session 5

4.
(a) Putting (L) = f (L) wL; then we have 0 (L) = f 0 (L) w, 00 (L) =
00
f (L) < 0, therefore, (L) is strictly concave and the …rst order condition
0
(L) = 0 characterizes a maxima.
(b) Write the FOC in the form F (L; w; ) = f 0 (L) w = 0; and we observe
FL = f 00 (L) < 0; Fw0 = 1 < 0; F 0 = f 0 (L) > 0:By the IFT, the derivatives of
0

the solution L = L(w; ) are given by

@L Fw0 ( )
= = <0
@w FL0 ( )

@L F0 (+)
= = >0
@ FL0 ( )
Hence, the demand for labor decreases with the wage rate , and increase with
the productivity parameter :

Exercise Session 6
3.
Step 1#:
A stationary point of f can be found by FOC:
8
@f
>
< @x1 = 2x1 x2 + 2x3 = 0
@f
> @x2 = x1 + 2x2 + x3 = 0
: @f = 2x + x + x = 0
@x3 1 2 3

Solve the above linear system of equations, we have only one stationary point,
x = (0; 0; 0):
Step 2#:
Check the Hessian matrix’s de…niteness:
2 3
2 1 2
H(x) = 4 1 2 1 5 ;
2 1 6

and the leading principal minors of the Hessian matrix are D1 = 2; D2 =

3; D3 = 4: H(x) is positive de…nite, and thus f (x) is strictly convex. The point
x = (0; 0; 0) is a local (and global) minimum.

1
 4.
Assume Cobb-Douglas utility function is concave (you should be able to
show it by yourself) and it is increasing at all (x1 ; x2 ) >> 0; hd(1): We need to
max u(x1 ; x2 ), s.t. p1 x1 + p2 x2 = w It turns out to be easier to use increasing
x1 ;x2
transformation
max ln x1 + (1 ) ln x2
x1 ;x2
1
s:t p1 x1 + p2 x2 = w: Since we have x2 = p2 (w p1 x1 ); we can rewrite

1
max ln x1 + (1 ) ln (w p1 x1 )
x1 p2
Using FOC ; take the …rst derivative w.r.t x1 ;
p1
(1 )=0
x1 w p1 x1
Solve it, we have
w
x1 =
p1
(1 )w
x2 =
p2
5.
(a). For = 1; we have u(x) = 1 x1 + 2 x2 :Thus the indi¤erence curves are
linear.
(b). Since every monotonic transformations of a utility function represents
the same preference, we shall consider

1
u
~(x) = ln u(x) = ln( 1 x1 + 2 x2 )

By L’Hopital’s Rule,

1 x1 ln x1 + 2 x2 ln x2 1 ln x1 + 2 ln x2
lim u
~(x) = lim = :
!0 !0 1 x1 + 2 x2 1+ 2

Since exp f( 1 + 2 )~
u(x)g = x1 1 x2 2 ; we have obtained a Cobb-Douglas util-
ity.
(c). Suppose x1 x2 ; we want to show
1
x1 = lim [ 1 x1 + 2 x2 ]
! 1

Let < 0; since x1 0; x2 0 we have

1 1
1 x1 1 x1 + 2 x2 )( 1) x1 ( 1 x1 + 2 x2 )

2
On the other hand , since x1 x2 , we have

1 x1 + 2 x2 1 x1 + 2 x1 =( 1 + 2 )x1

Hence 1 1
( 1 x1 + 2 x2 ) ( 1 + 2) x1
Therefore
1 1 1
( 1) x1 ( 1 x1 + 2 x2 ) ( 1 + 2) x1
1
Letting ! 1; we obtain lim [ 1 x1 + 2 x2 ] = x1 by Sandwich Theorem.
! 1