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Assignment 1

The document outlines an economics assignment from Addis Ababa Science and Technology University, focusing on consumer behavior with a budget constraint and utility maximization using a Cobb-Douglas utility function. It includes graphical representations of budget lines under various scenarios and calculations for optimal consumption and production levels based on a given production function. Additionally, it discusses the three stages of production in relation to labor employment and productivity.

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tadesseyonatan2
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9 views

Assignment 1

The document outlines an economics assignment from Addis Ababa Science and Technology University, focusing on consumer behavior with a budget constraint and utility maximization using a Cobb-Douglas utility function. It includes graphical representations of budget lines under various scenarios and calculations for optimal consumption and production levels based on a given production function. Additionally, it discusses the three stages of production in relation to labor employment and productivity.

Uploaded by

tadesseyonatan2
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Addis Ababa Science and

Technology University
Introduction to economics
Group Members ID. N
1. Yonatan Tadesse ETS 1744/14
2. Yonatan ETS 17/14
3. Yonatan ETS 17/14
4. Yonatan ETS 17/14
5. Yonatan ETS 17/14
6. Yonatan ETS 17/14
7. Yonata. ETS 17/14
Section: C1
Submitted to:

Assignment # 1
1. Assume a consumer has a monthly income of 100$ to spend on kg of
orange (X) and banana (Y). If the prices of X and Y per kg is 5$ and 2$,
respectively:

a) Draw budget line of the consumer.


 The horizontal axis represents the quantity of oranges (X) and the
vertical axis represents the quantity of bananas (Y). The slope of the
budget line is the ratio of the prices of the two goods, which is -5/2.
The intercepts of the budget line are (20, 0) and (0, 50), which
represent the maximum amount of each good that the consumer can
purchase given their income of $100.
b) Explain about and show graphically what will happen to the budget
line if:

i) Income of the consumer increases by 10$.


 If the income of the consumer increases by $10, the new budget line
will shift outward parallel to the original budget line. The intercepts
of the new budget line will be (30, 0) and (0, 60), which represents
the new maximum amount of each good that the consumer can
purchase.
ii) Price of Y decreases to 4$.
 If the price of Y decreases to $4, the slope of the budget line will
change to -5/4, making the budget line flatter. The intercepts of the
new budget line will be (25, 0) and (0, 50), which represents the new
maximum amount of each good that the consumer can purchase.
iii) Price of X increases to 2.5$.
 If the price of X increases to $2.5, the slope of the budget line will
change to -2.5/5, making the budget line steeper. The intercepts of
the new budget line will be (16, 0) and (0, 40), which represents the
new maximum amount of each good that the consumer can
purchase.
iv) Government imposes 10$ of income tax.
 If the government imposes an income tax of $10, the budget line will
shift inward parallel to the original budget line. The intercepts of
the new budget line will be (18, 0) and (0, 45), which represents the
new maximum amount of each good that the consumer can purchase

2. Consider the following Cobb-Douglas utility function 𝑢 (𝑥1, 𝑥2) = 𝑥1𝛼


after paying the tax.

𝑥2𝛽. Assume that 𝑝1 and 𝑝2 are prices of 𝑥1 and 𝑥2, respectively.

spent on 𝑥1 and 𝑥2, find:


Assuming further that the consumer has m income to be exhaustively

a) Find the marginal rate of substitution (MRS) of 𝑥1for 𝑥2


 The marginal rate of substitution (MRS) of 𝑥1 for 𝑥2 is given by the
ratio of the partial derivatives of the utility function with respect to
the two goods:

MRS = MU𝑥1 / MU𝑥2

where MU𝑥1 and MU𝑥2 are the marginal utilities of 𝑥1 and 𝑥2,
respectively. Using the Cobb-Douglas utility function, we have:

MU𝑥1 = α𝑥1^ (α-1) 𝑥2^β

MU𝑥2 = β 𝑥1^α 𝑥2^ (β-1)

Therefore, the MRS of 𝑥1 for 𝑥2 is:

MRS = (α𝑥1^ (α-1) 𝑥2^β) / (β𝑥1^α𝑥2^ (β-1))

= (α/β) (𝑥1/𝑥2) ^ (α-β)

b) Solve for the optimums of 𝑥1 and 𝑥2


 To find the optimums of 𝑥1 and 𝑥2, we need to maximize the utility

be expressed as: 𝑝1𝑥1 + 𝑝2𝑥2 = 𝑚


function subject to the budget constraint. The budget constraint can

We can use Lagrange multipliers to solve for the optimums. Let 𝜆


be the Lagrange multiplier. Then the Lagrangian function is:

𝐿 = 𝑥1𝛼 𝑥2𝛽 + 𝜆 (𝑚 - 𝑝1𝑥1 - 𝑝2𝑥2)

Lagrangian function with respect to 𝑥1, 𝑥2, and 𝜆, and set them
To find the optimums, we need to take partial derivatives of the

equal to zero:

∂𝐿/∂𝑥1 = 𝛼𝑥1^ (𝛼-1) 𝑥2^ (𝛽) - 𝜆𝑝1 = 0

∂𝐿/∂𝑥2 = 𝛽𝑥1^ (𝛼) 𝑥2^ (𝛽-1) - 𝜆𝑝2 = 0

∂𝐿/∂𝜆 = 𝑚 - 𝑝1𝑥1 - 𝑝2𝑥2 = 0


Solving these equations simultaneously, we get:

𝑥1 = (𝛼𝑚/𝑝1) ^ (1/ (𝛼+𝛽))

𝑥2 = (𝛽𝑚/𝑝2) ^ (1/ (𝛼+𝛽))

These are the optimal values of 𝑥1 and 𝑥2 that maximize the utility
function subject to the budget constraint.

(Q) is a function of labor (L): 𝑄 = 𝑓 (𝐿) = 7𝐿 + 10𝐿2 − 𝐿3 determine:


3. Assuming a firm faces the following production function, where output

a) The amount of employment that maximizes average productivity

 Average productivity is defined as output per unit of labor, or AP =


Q/L. The amount of employment that maximizes AP is the point
where the slope of the AP curve is zero, or where the derivative of
AP with respect to L is equal to zero. Using the production function,
we can derive the expression for AP:

AP = Q/L = 7 + 10L - L2

Taking the derivative of AP with respect to L and setting it equal to


zero, we get:

dAP/dL = 10 - 2L = 0

Solving for L, we get L = 5, which is the amount of employment that


maximizes AP.

b) The amount of employment that maximizes total production


 Total production is given by the production function,
Q = 7L + 10L2 - L3. To find the amount of employment that
maximizes total production, we need to take the derivative of Q with
respect to L and set it equal to zero:
dQ/dL = 7 + 20L - 3L2 = 0
Solving for L, we get L = 7.56, which is the amount of employment
that maximizes total production.

c) Based on the results you obtained from (a) and (b) above, show
graphically the three stages of production.
 The three stages of production can be illustrated graphically using
the marginal product of labor (MPL) curve. MPL is the additional
output produced by each additional unit of labor, or the derivative
of the production function with respect to L. Using the production
function, we can derive the expression for MPL:
MPL = dQ/dL = 7 + 20L - 3L2
The three stages of production are:
1. Increasing returns to labor: When L is small, MPL is increasing
and the firm is experiencing increasing returns to labor. In this
stage, the firm should hire more workers to increase production.
2. Diminishing returns to labor: When L is moderate, MPL is
decreasing but positive, and the firm is experiencing diminishing
returns to labor. In this stage, the firm should still hire more
workers, but the marginal productivity of each worker is
decreasing.
3. Negative returns to labor: When L is large, MPL becomes
negative and the firm is experiencing negative returns to labor.
In this stage, the firm should reduce its workforce to increase
production.
The graph of the production function and the MPL curve is shown
below:
The three stages of production are highlighted in the graph. At L=5, the
MPL curve is at its maximum and the AP curve is tangent to the MPL
curve, indicating that the firm is at the point of maximum average
productivity. At L=7.56, the production function is at its maximum,
indicating that the firm is at the point of maximum total production.

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