Problems for the Review Session 3

General Equilibrium Example

Consider an economy consisting of 2 individuals: Ann and Bob. There are 2 goods in the economy x and y. Ann has 18 units of good x and 4 units of good y and Bob has 3 units of good x and 6 units of good y. Anns preferences for these goods are given by U A (x, y) = xy, so that her MRS is M RS A = y x (1)

Bobs preferences are given by U B (x, y) = xy 2 , so that his MRS is M RS B = y 2x (2)

1. Draw an Edgeworth box for this economy and show the endowment point. 2. Will Ann and Bob benet from trade? Can you propose an example of a trade. 3. Algebraically nd the contract curve and draw it in the Edgeworth box. 4. Can you graphically characterize the core? Now suppose Ann has 2 units of good x and 3 units of good y and Bob has 4 units of good x and 3 units of good y. Anns preferences for these goods are given by U A (x, y) = x + ln(y), so that her MRS is M RS A = y is M RS B = y 2 (4) (3)

Bobs preferences are given by U B (x, y) = x + 2ln(y), so that his MRS

Please draw Edgeworth box, show the endowment point and nd the contract curve and the core for this case.

Problems for the Review Session 3

General equilibrium with perfect compliments

Arthur likes to add exactly 2 packs of sugar into his cup of tea, and Brian likes to add just 1 pack of sugar into his cup of tea. They do not drink tea without sugar, and do not use sugar for any other purposes. Arthur currently has 5 packs of sugar and 4 cups of tea, and Brian has 9 packs of sugar and 4 cups of tea. With Arthur at the lower axis and Brian at the upper axis, packs of sugar on the horizontal axis and cups of tea on the vertical axis: 1. Draw an Edgeworth box, show the endowment point and draw the IC curves for both consumers. 2. Starting from the endowment point can you make one of the consumers better o without making the other one worth o? 3. Can you tell whether or not the following allocations belong to the contract curve: (1, 4) to Arthur and the rest to Brian; (12, 1) to Arthur and the rest to Brian? 4. Please show graphically the contract curve and the core.

Production with one input

Factory A produces pencils using labor. The production function is given by 1 L3 + 4L2 4L (5) 3 so that the Marginal Product of Labor is given by: M P (L) = L2 + 8L 4 (6)

The factory hires labor at a wage rate of w = 6 dollars per hour and sells pencils at a price of 2 dollars. What is the optimal number of hours that the factory should use? Draw the MRPL curve, show the wage on this graph. Show the prot maximizing point, show the rst prot minimizing point. For both of these points show the total cost area, total revenue area, and prots and losses. How do you nd graphically the break-even point. Show the labor demand curve. Suppose that hiring labor becomes very expensive and wage rate goes up to 16 dollars per hour. What is the optimal number of hours that the factory should use now? What is the break-even point for this wage. 2

Problems for the Review Session 3

AC, MC and TC

Suppose your are producing suits and your Total Cost is given by T C = Q3 18Q2 + 123Q, then your Marginal Cost is M C = 3Q2 36Q + 123. The price of a suit is p = 90 dollars. Derive an equation for the Average Cost. What is the optimal amount of suits that you produce. What is your prot at that point. Draw the MC and AC curves and show the price. Show your total costs and total revenues at the optimal point. Find the break-even point. Show the Supply curve.