Answers to Econ 210A Midterm, October 2010

Question 1.
f (x1 , x2 ) =

max {x1 , x2 }

A. The function f is homogeneous of degree 1/2. To see this, note that for all
t > 0 and all (x1 , x2 )
p
f (tx1 , x2 ) =
max {tx1 , tx2 }
p
=
t max {x1 , x2 }
p
1/2
max {x1 , x2 }
(1)
= t
= t1/2 f (x1 , x2 )

B. The function f is neither concave, nor quasi-concave. One should be able to

see this quickly by drawing an indifference curve and seeing that the at-leastas-good set is not convex. Therefore the function is not quasi-concave. Since a
concave function must be quasi-concave, f cannot be concave either.
One can show that the function is not quasi-concave by means of a single
example. Let x = (1, 0) and x0 = (0, 1). Then f (x) = 1 f (x0 ) = 1. Now
consider the convex combination tx + (1 t)x0 = (t, t) where 0 < t < 1. If f is
quasi-concave, then it must be that f (tx + (1 t)x0 ) f (x0 ). But f (tx + (1
t)x0 ) = t < f (x0 ) = 1. So f cannot be quasi-concave. We also note from this
same example that tf (x) + (1 t)f (x0 ) = 1 > f (tx + (1 t)x0 ) = t. But if f is
a concave function tf (x) + (1 t)f (x0 ) f (tx + (1 t)x0 ), so x is not a concave
function.
C The function f is not a convex function. The square root sign should be a
tipoff. Square root is a strictly concave function. To show that f is not a convex
function, consider the two points x = (1, 0) and x0 = (4, 0). Then f (x) = 1 and
f (x0 ) = 2. Therefore
1
1
f (x) + f (x0 ) = 2.5.
2
2
But

1
1
1
1
f ( x + x0 ) = f (2.5, 0) = 2.5 < f (x) + f (x0 )
2
2
2
2
The function f is a quasi-convex function. A quick way to see that this
must be true is to look at an indifference curve and see that it looks like the
worse-than sets must be convex.
To show this formally, suppose f (x1 , x2 ) f (x01 , x02 ). Then f (x1 , x2 ) =
max x1 , x2 , x3 , x4 If 0 < t < 1, then
f (tx + (1 t)x0 )

max{tx1 + (1 t)x2 , tx01 + (1 t)x02 }

max x1 , x2 , x3 , x4
= f (x1 , x2 )

Therefore if f (x) f (x0 ), then f (tx + (1 t)x0 ) f (x0 ) which means that f is
quasiconcave.
Question 2. Ms Rodents utility function is
2

u(x1 , x2 ) = (min{x1 , x2 }) .
Wild Things utility function is
u(x1 , x2 ) = max{x1 , x2 }.

A. Ms Rodents Marshallian demand function is

m
x1 (p, m) =
p1 + p2
x2 (p, m) =

m
p1 + p2

Her indirect utility function is


v(p, m) =

m
p1 + p2

2

Her expenditure function is

e(p, u) =

u(p1 + p2 ).

Her Hicksian demand function is

h1 (p, u) =
h2 (p, u) =

u
u

B. Wild Things demand function is defined as follows:

If p1 < p2 , x1 (p, m) = pm1 and x2 (p, m) = 0.
If p1 > p2 , x1 (p, m) = 0 and x2 (p, m) = pm2 .
If p1 = p2 = p, then Wild Thing can maximize his utility at either of two
m
possible demand vectors. These are (x1 , x2 ) = ( m
p , 0), and (x1 , x2 ) = (0, p ).
Wild Things indirect utility function is
v(p, m) =

m
min{p1 , p2 }

His expenditure function is

e(p, u) = min {p1 , p2 }u
If p1 < p2 , his Hicksian demands are h1 (p, u) = u and h2 (p, u) = 0.
If p1 > p2 , his Hicksian demands are h1 (p, u) = 0 and h2 (p, u) = u.
2

If p1 = p2 = p, then there are two bundles either of which would minimize

cost of achieving utility u. These are (m/p, 0) and (0, m/p).
C. The Slutsky substitution matrix for Ms Rodent is


0 0
0 0
The substitution effect of a price change is zero. If prices are changed, she
will continue to consume equal amounts of the two goods. If her income is
adjusted so that she is exactly as well off as before the price change, she will
consume exactly as much of each bundle as before the price change.
Question 3.
f (x1 , x2 ) = x1 + x2 + ax1 x2

x2
x21
2
2
2

A. The gradient of f is the vector

(1 + ax2 x1 , 1 + ax1 x2 ).
Evaluated at (x1 , x2 ) = (1, 2), this gradient is (2a, a 1).
B. The Hessian of f is


1
a

a
1

C. The function f will be concave if and only if the Hessian is negative semidefinite. This will be the case if the determinants of the odd-numbered principle
minors are nonpositive and the even-numbered are nonnegative. In the case
of our matrix this means that the diagonals must be non-positive and the 2x2
Hessian must be non-negative. In out case, both diagonals are negative. The determinant of the Hessian is 1a2 which is nonnegative if and only if 1 a 1.
So f is concave if and only if 1 a 1.
D. The point at which the gradient of f is zero will be a global max if f is
strictly concave. The function f will be strictly concave if 1 < a < 1. The
gradient of f is zero at (x1 , x2 ) if 1 + ax2 x1 = 0 and 1 + ax1 x2 = 0. Solving
these two equations, we find
x1 = x2 =

1
1 a.

Assuming that 1 < a < 1, at the point of maximization, we have

f (x1 , x2 ) = 2

1
a1
1
+
=
.
2
1 a (1 a)
1a

Notice that if a 1, then f (x, x) = 2x + (a 1)x2 , which can be made

arbitrarily large by choosing x large enough. So f has no maximum.

If a < 1, then f (x, x) = (a 1)x2 where a 1 > 0. Therefore f

can be made arbitrarily large by choosing x large enough. So again f has no
maximum.
We have one more case to worry about. What if a = 1? Here is one way
to dispose of this case. If a = 1, then f is concave, but not strictly concave.
If there is a global maximum, it must be at the point


1
1
0
,
= (1/2, 1/2).
x =
1a 1a
Consider the function F (t) = f (x0 + ty). Consider the Taylors series expansion
of F , which is
F (t) = F (0) + tF 0 (0) +

t2 00
F (t) + multiples of higher derivatives of F.
2

0
Since the P
Hessian
P H(x ) of f is negative semidefinite when a = 1, 00we know that
00
F (t) = i j Hij yi yj 0 for all y. The second derivative F (t) does not
depend on t. So all higher derivatives are zero. Therefore

F (t) = F (0) + tF 0 (0) +

t2 00
F (t) 0
2

. This means that for all y and all t, F (x0 + ty) F (0 ) which implies that f
achieves a global maximum at x0 = (1/2, 1/2) . At this point, f (x0 ) = 1/2.
Here is an alternative way to show the result for a = 1. This method has
the advantage of giving us a full description of all the points at which f takes a
global maximum. If a = 1, then
f (x1 , x2 ) =

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

The first term of this expression is necessarily non-positive and is maximized

when x1 + x2 = 1. Therefore f (x1 , x2 ) is maximized whenever x1 + x2 = 1 and
at any such point takes a maximum value of 1/2.
Question 4.
A. Eulers theorem on homogeneous functions is as follows:
If f is a real valued function of n variables and if f is homogenous of degree
k, then
n
X
f (x1 , . . . , xn )
xi
= kf (x1 , . . . , xn ).
xi
i=1
B. If f is homogeneous of degree k, then partial derivative functions fi (x1 , . . . , xn )
are homogeneous of degree k 1.
C. Proof of Eulers theorem:
If f is homogeneous of degree k, then
f (tx1 , . . . , txn ) = tk f (x1 , . . . , xn )
4

for all t > 0 and all x in the domain of f . Therefore the derivative with respect
to t of the left side of this identity is equal to the derivative of the right side
with respect to t. This implies that
n
X

xi

i=1

f (tx1 , . . . , txn )
= ktk1 f (x1 , . . . , xn )
xi

for all t > 0. In particular, this equation holds when t = 1, which means that
n
X
i=1

xi

f (x1 , . . . , xn )
= kf (x1 , . . . , xn ).
xi

Proof that if f is homogeneous of degree k, its partial derivatives are homogeneous of degree k 1:
If f is homogeneous of degree k, then
f (tx1 , . . . , txn ) = tk f (x1 , . . . , xn )
for all t > 0 and all x in the domain of f . Differentiate both sides of this
equation with respect to xi . This gives us
t

f (x1 , . . . , xn )
f (tx1 , . . . , txn )
= tk
.
xi
xi

Dividing both sides of this equation by t, we have

f (tx1 , . . . , txn )
f (x1 , . . . , xn )
= tk1
xi
xi
which means that the function

f (x1 ,...,xn )
xi

is homogeneous of degree k 1.