KENYATTA UNIVERSITY

UNIVERSITY EXAMINATIONS 201712018

FIRST SEMESTER EXAMINATION FOR THE DEGREE OF DOCTOR OF PHILOSOPHY
IN ECONOMICS

EET 900: MICROECONOMICS I

DATE: Friday, 2nd February, 2018 TIME: 9.00 a.m. - 12.00 p.m.
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INSTRUCTIONS: Answer ALL questions.
Question One

1. The total cost of a cost-minimizing firm is given as:

C(q,wl,W2)= a+(q+0.5q2)(w/w; +(w~Wf)+W2). ais a positive parameter, WI and
w2 are the unit prices of each of the two variable inputs and q is the output. Does the
function meet the tenets of a cost-function? Demonstrate (10 marks)
11. Consider a monopoly firm with demand function given as y = 50 - P and cost function
given as c(y)=5y+0.5y2,
Determine the profit maximizing output and price levels (3 marks)
Suppose a price control is set on the firm requiring that its price be not higher than $23,
and the firm also faces a constraint that y c:; 50 - p. Analyze the profit maximization
problem of the firm, giving all relevant cases. (12 marks)

Question Two

When solving optimization problems, one is likely to encounter challenges dealing with
technology represented by a production function which is not differentiable. Using Kuhn Tucker
Theorem, solve the following optimization problems.

1. Given a production function as y = 3x, + 5x2, obtain the corresponding ordinary input
demand functions and the cost function. (15 marks)
ll. Consider a firm with two plants each with cost functions ci (YI) = 10YI and c2 (Y2) = Y; such
thaty = YI + Y2' and fixed factor prices. Derive the firm's cost function. (10 marks)

Question Three

(a) Let X = R;. Verify that X satisfies all five properties required of a consumption set.
(2 marks)
(b) A consumer has lexicographic preferences over x E R;
if the relatiori c satisfies x I ?:: X2

W henever
enever x.
XI = XIx.' ' or
e = XI2d2an
x2 ~ x22 •
XI I
(i) Sketch an indifference map for these preferences. (2 marks)

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 (ii) Can these preferences be represented by a continuous utility function? Why or why not?
(1 mark)

11

(c) Suppose u(x) = If;(xJ is strictly quasiconcave with J;'(xi) for all i. The consumer

faces fixed prices p » 0 and has income y> O. Assume x(p, y»> o.

(i) Show that if one good displays increasing marginal utility at x(p, y), all other goods
must display diminishing marginal utility there. (1 mark)

(ii) Prove that if one good displays increasing marginal utility and all others diminishing
marginal utility at x(p, y), then one good is normal and all other goods are inferior.
(1 mark)

(iii) (iii) Show that if all goods display diminishing marginal utility at x(p, y), then all
goods are normal. (1 mark)

(d) Consider a situation with two producers, A and B. Producer A has a production function
X = 0.4L025 where X is output and L the input of labour. Let Xp be the price of X; and W
be the wage of labour. Producer B buys X and produces Y from it with a production
function Y = X05. The price of Y is Y p. The markets for Yand L are assumed to be
competitive. Producer B acts as a competitor in the market for X Required:
i) Derive the equilibrium values of L, X and Y. (2 marks)
ii) How do L, X and Y change as W, Xp and Yp change? (2 marks)

(e) Suppose initially a consumer has an income mO =100 and faces the following prices of good
xi and X2: p~ = p~ = 1 . If the government imposes a tax on the good XI so that PI rises to

p~ = 4. What amount of additional income would be needed to compensate the consumer

so that he/she remains on the same level of utility as before the imposition of the tax?
(3 marks)
Question Four
Ali, "the crocodile", lives in the dark water of Creek in the Arboretum just beside the certain
campus. To the delight of the ducks there, Ali is a vegetarian. Ali earns income from being
employed by the campus as a life guard at Creek. His task is to rescue students who fall into the
water from time to time. He is especially busy around end of semester exams when more
students than usual jump into water out of despair. When being rescued by Ali, usually their
mood lights up quickly in anticipation of a cool selfie with a "crocodile" that can be shared on
Facebook. By the time they relapse upon realizing that the water damaged their cell phone
beyond repair, the authorities have arrived to help (with their cell phones). Anyway, let's not
digress further. While we certainly appreciate Ali's work, our academic interest is focused on his
consumption behaviour. Being a vegetarian, his main diet consists of ' 'nduma": They have the
inconvenient feature of getting stuck between his 72 teeth. So, he is also a rather heavy consumer
of toothpicks.
Finally, there are his frequent gifts he purchases for Mathilda. Mathilda! She is the duck
of the Arboretum who waddles most elegantly with her petite legs by delightfully moving
well-shaped hips. He is really in love with her; at a platonic level of course so that nobody
gets physically hurt.

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 We write Xa, x., Xg ~ 0 for the amounts of his consumption of' 'nduma"; toothpicks, and
gifts, respectively. We assume for simplicity that these goods are infinitesimally divisible.

Let x=(xo'x"xg)), We assume that his utility function is given by u(xa,x(,Xg)=x:x(Bx~-a-B

with a,e E (0,1) and a + e < 1. His income or wealth is denoted by w> 0. Finally, we denote by
°
Pa; Pt; Pg> the prices of' 'nduma": toothpicks, and gifts, respectively, and p = (Pa; Pt; pg).

(i) Use the Kuhn-Tucker approach to derive step-by-step the Walrasian demand function
x(p;w). Verify also second-order conditions. (2 marks)
(ii) To be honest, we do not really know whether Ali has the Cobb-Douglas utility function
stated above. Would Ali want to differently substitute a marginal amount of' 'nduma" for
some toothpicks when having a differentiable utility function different from the one above
and optimally demanding positive amounts of all goods? Explain. (1 mark)
(iii) You would expect that the more' 'nduma" Ali eats, the more they get stuck in his teeth and
the more toothpicks he purchases. In light of such considerations, does it make sense to
assume Ali has the utility function above? Explain. (1 mark)
(iv) Derive Ali's indirect utility' function (denote it by v(p;w»). (2 marks)
(v) Verify that Ali satisfies Roy's identity with respect to' 'nduma": (1 mark)
(vi) When Professor Yakuu interviews Ali about how exactly he arrives at his optimal
consumption bundle, Ali expresses ignorance about maximizing utility subject to his
budget constraint. Instead, he seems to minimize his expenditure on consumption such that
he reaches a certain level of utility. A smart undergraduate student walks by and claims that
this is clear evidence against the assumption of utility maximization in economics. Since
Professor Yakuu hates Cobb-Douglas utility functions and boring calculations, he sends the
student to you so that you can show him how expenditure minimization works. Again, use
the Kuhn-Tucker approach to derive the Hicksian demand function. (2 marks)
(vii) Derive the expenditure function. Show that the expenditure function is homogeneous of
degree 1 in prices, strictly increasing in it as well as nondecreasing and concave in the
price of each good. (2 marks)
(viii) Professor Yakuu cannot compute the Hicksian demand using Kuhn-Tucker without a cup
of tea. Unfortunately, Ali has no cup of tea to offer. Yet, he could offer Professor Yakuu
his expenditure function. Is there a way to quickly calculate the Hicksian demand from the
expenditure function without cup of tea? (1 mark)
(ix) Verify the (own price) Slutsky equation for the example of ' 'nduma": Which term in the
(own price) Slutsky equation refers to the substitution effect? (1 mark)
(x) Because of the drought, the price of' 'nduma" changes from. The campus is committed to
keep Ali as well off as before the price change. The newly campus management turns to
Professor Yakuu for advice on the exact amount to be deducted from the budget of the
university and paid to Ali as compensation for the price change. Unfortunately, Professor
Yakuu is so immersed in exciting new research that he is extremely slow in answering his
email. Luckily, the Senior university administrator requests the university calculate the
amount. (2 marks)

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