M.A.

(P) [Summer Semester 2013]

Course 001: Microeconomic Theory

Course Outline
S.C.Panda
Topics

1. CONSUMER THEORY

a. Axiomatic Foundation of Utility Analysis
b. Comparative Static Results
c. Duality
d. Revealed Preference
e. Measurement of Welfare Change
f. Consumer choice under uncertainty

2. PRODUCER THEORY

a. Technology
b. Profit Maximisation of a competitive firm
c. Cost minimisation
d. Duality
e. Efficiency



Reading List
Core Texts

1. G. Jehle and P. Reny: Advanced Microeconomic Theory, Pearson, 2
nd
edition.
Recommended chapters: 1-3.

2. H. Varian: Microeconomic Analysis, Norton, 3rd edition. Recommended Chapters: 1-11.

3. Mascolell, Whinston and Green: Microeconomic Theory, OUP. Recommended Chapters:
Ch.1 (1A&1B), 2,3(excluding3F,H), 5,6 (6A,B).


Support Material:

1. H.A.J. Green: Consumer Theory, Macmillan. (For an excellent non-mathematical
introduction to axiomatic consumer theory). Recommended Chapters: 1-8, and technical
appendix.

2. C. Birchenhall and Paul Grout: Mathematics for Modern Economics, Heritage. (Has a
useful set of solved examples, particularly on duality).

3. E. Silberberg: The Structure of Economics, Recommended Chapters: 7,8,9,10,11.1.



PROBLEM SET
COURSE 001

(Consumer Theory and Production)

S.C. PANDA

1. Let R be a binary weak preference relation and let P and I be the asymmetric and
symmetric factors of R respectively. Then show that

a. Transitivity of R implies transitivity of P and transitivity of I

b. If R is complete then transitivity of P and I together imply transitivity of R.
What happens if R is incomplete?

2. Suppose R is complete and P and I are both transitive. Show that x,y,z c X, xPy and
yIz xPz.

3. Suppose a consumers preference relation over X = {x,y,z} is given by xIy and yIz and
xPz. Show that the weak preference relation R violates transitivity. Can this preference
relation be represented by a real valued utility function?

4. In a two commodity world, a consumer always prefers a consumption bundle with greater
total weight to a consumption bundle with lower total weight; however if the total
weights are same he prefers the bundle containing more of commodity 1. Draw his
preference map and show that this preference ordering violates continuity property.

5 Consider a consumer whose preference relation is defined over the non-negative quadrant
by (x
1,
x
2
) P (y
1,
y
2
) if (x
1
+ x
2
) < (y
1
+ y
2
). Does this preference relation satisfy local non-
saturation? Suppose these are the only two consumption goods and the consumer faces
positive prices. Where will the consumer attain equilibrium?

6. If R is strictly convex, show that a consumer will spend all his income at optimum if the
budget set contains no bliss point.

7. A consumer discovers that as he consumes more mangoes his marginal utility from
mangoes increases. Assume that his preferences are represented by a utility function.
Can this consumer's preferences be convex?

8. Consider a quasilinear utility function U = x
2
+ log x
1
. Show that this function has
vertically parallel indifference curves. Show also that the price consumption path with
respect to changes in P
1
is horizontal.

9. Check whether the following utility functions are strictly quasiconcave:

a.
x
+
x
= U
2
2
2
1
b. 0 > , ,
x

x
= U
2 1
| o
| o


c.
x x
+
x x
+
x x
= U
3 1 3 2 2 1


10. Construct Marshallian and Hicksian demand functions for the utility function

x
+
x
+
x x
= U
2 1 2 1


11. A consumer's utility function is given by

U (x) =
x
+ 1
x
+
x
+ 1
x
2
2
1
1

Show that a sufficient condition for x
2
= 0 at optimum is

) p p (
m
- 1 < )
p
p
(
2 1 2
1
Where p
1
, p
2
are prices and m is the income of the consumer.

12. Show that all goods cannot be inferior goods.

13. Show that in a two-commodity world, the goods must be Hicks - Allen substitutes.

14. Show that diminishing marginal rate of substitution neither implies nor is implied by
diminishing marginal utility.
(Hint : construct utility functions satisfying one property but violating the other)

15. Show that the demand functions obtained by maximising a utility function U(x) subject
to a budget constraint px s m are invariant under a strictly increasing transformation V(x)
= F (U(x)) of the utility function.

16. An individual has a utility function
F

L
= U
3
2
3
1
where L = Leisure and F = Food.
Suppose the individual has an initial endowment of leisure of 24 hours, non-wage income
M and the wage rate is w per hour while price of food is p.

a. Derive the individual's demand function for food and leisure and supply function
of labour. Under what condition labour supply will be zero?

b. Derive the individual's demand function for leisure and food with real income
held constant.

c. Show that own substitution effect is negative and cross substitution effects are
symmetric.

17. Consider an additive utility function

)
x
(
U
+ ... + )
x
(
U
+ )
x
(
U
= U
n n 2 2 1 1
where and 0 < )
x
( "
U
i i

for i = 1,2, ..,n. The budget constraint is p
1
x
1
+p
2
x
2
+...+p
n
x
n
= m. Determine admissible
signs of income effect and price effect.

18. Consider the class of utility functions

)
x
-
x
...( )
x
-
x
( = U
n 1 0
n n
0
1 1
o o


where 1 =
i
o
and
x
......
x
0
n
0
1
can be thought of as subsistence level of goods.
This class of utility functions is known as Stone-Geary. Show that this utility function
0 > )
x
(
U i i
'
generates demand systems with the characteristic that expenditure p
j
x
j
on any good x
j
is a
linear function of all prices and income.

19. Given the utility function
x
1
-
x
1
- = U
2 1
derive the indirect utility function and the
expenditure function. Compute the ordinary and compensated demand functions from
the indirect utility function and expenditure function respectively.

20. An indirect utility function is given by
P P
4
m
= V
2 1
2
. Establish the Slutsky
decomposition.

21. Derive the direct utility function from the following expenditure functions:

a. ) u p p ( = u) e(p, b + a
1
b
2
a
1


b.
u
) bp + ap ( = u) e(p,
2 1
2 / 1



22. A consumer has an indirect utility function V(p,m) = m / min (p
1,
p
2
). Derive the utility
function and the expenditure function for this consumer. Also, derive the demand
function for good 1.

23. A consumers expenditure function is given as e (P,U) = UP
1
P
2
/ (P
1
+P
2
). Derive the
direct utility function and Marshallian demand functions for both commodities.


24. Suppose a consumer's utility function is given by U(x
1
, x
2
) = min(x
1
, x
2
). To start with
his income is Rs.10/- and price of each good is 50 paise. If the price of good 1 falls to 25
paise what will be compensating and equivalent variations?

25. A consumer's utility function is )
x
,
x
( = U
2 1
max . Suppose his income is 12, p
1
=2
and p
2
=1. If p
1
falls to 0.5 what is the compensating variation?

26. Suppose U is a function of two commodities x and y. Suppose m=100, P
y
=1 and P
x
falls
from 1 to 0.25. Calculate CV and EV and show the relationship when (a) U = xy (b) U
= 2x - x
2
+ y
27. Which of the following sets of observations of price-quantity data are consistent with
strong axiom of revealed preference?

a. p
1
= (1,2,3) x
1
= (3,2,1)
p
2
= (2,1,2) x
2
= (2,2,1)
p
3
= (3,5,1) x
3
= (1,2,1)

b. p
1
= (3,4,1) x
1
= (5,1,3)
p
2
= (2,3,2) x
2
= (3,3,3)
p
3
= (5,3,1) x
3
= (4,2,2)

28. Construct a firm's short run and long run cost functions if the production function
is given by
Q = L

29. Derive the production function if the cost function is given by C = Q w

r
1-

where w and r are factor prices.
30. A firm's profit function is )
r
1
+
w
1
(
4
p
=
2
t , where p is the output price and w, r
denote input prices. Find the firm's supply and input demand function.

31. Consider the production function Q=KL
2
. At given prices show that a finite profit
maximum does not exist; however, for any given output, show that a cost minimising
input combination exists. Find out the cost function in this case.

32. A profit maximising competitive firm has the production function

L K
3 = Q
3
1
2
1
.

a. Derive the demand functions for inputs and supply function for output and check
homogeneity property.

b. Derive the profit function and check the homogeneity property.

c. Show that cross price effects are symmetric.

33. Show that a competitive firm's supply curve cannot be downward sloping and the
unconditional input demand curves cannot be upward sloping.

34. A consumer who conforms to the Von Neumann Morgenstern axioms is faced with four
situations A, B, C, D. He prefers A to B, B to C and C to D. Suppose the consumer is
indifferent between B and a lottery ticket with probabilities of 0.4 and 0.6 for A and D
respectively and that he is indifferent between C and a lottery ticket with probabilities 0.2
and 0.8 for B and D respectively. Construct a set of von Neumann - Morgenstern utility
numbers for the four situations.

35. Suppose a consumer has a utility function U = m
2
where m is money income. He has 5
rupees which he can use to buy a lottery ticket which gives a prize of Rs. 100 with
probability 0.05. Using expected utility hypothesis, check if he would buy this lottery.