BEEM103 –Optimization Techniques for Economists Dieter Balkenborg

Departments of Economics
Class Exercises Week 3 - Solutions University of Exeter

Exercise 1 A monopolist produces two commodities in quantities Q1 and Q2 . The prices

for the two commodities are P1 and P2 , respectively. Demand for each commodity is given
by
Q1 = 50 2P1 + P2 Q2 = 75 + 2P1 3P2
Total costs for producing Q1 (respectively Q2 ) units of the …rst (second) commodity are
15Q1 or 10Q2 , respectively.

Solution 1

1 Express the total revenue from sales of the two commodities in terms of the variables
Q1 ; Q2 ; P1 ; P2 : Then, using the demand functions express total revenue as a function
T R (P1 ; P2 ) of the prices only.
SOLUTION:
T R = P1 Q1 + P2 Q2 = P1 (50 2P1 + P2 ) + P2 (75 + 2P1 3P2 )

2 Assuming that he sells what he is producing, express total production costs as a function
T C (P1 ; P2 ) of the prices only.
SOLUTION:
T C = 15Q1 + 10Q2 = 15 (50 2P1 + P2 ) + 10 (75 + 2P1 3P2 )

3 Find a critical point of the pro…t function.

SOLUTION:
(P1 ; P2 ) = T R (P1 ; P2 ) T C (P1 ; P2 )
= (P1 15) (50 2P1 + P2 ) + (P2 10) (75 + 2P1 3P2 )
= 2P12 + 3P1 P2 3P22 + 60P1 + 90P2 1500
The critical point satis…es the simultaneous system of equations
@
= 60 4P1 + 3P2 = 0
@P1
@
= 90 + 3P1 6P2 = 0
@P2
or
60 4P1 + 3P2 = 0
3P1 + 90 6P2 = 0
The critical point is given by P2 = 36; P1 = 42:
4 Use second partial derivatives and the Hessian matrix to show that the critical point is
a relative pro…t maximum.
SOLUTION: The Hessian matrix of the pro…t function is
" @2 @2
#
@P12 @P1 @P2 4 3
H= @2 @2 =
@P @P @P 2
3 6
2 1 2

and has the determinant 15 > 0. The critical point is hence a peak or a trough.
@2
Since @P 2 < 0 it is is a peak, i.e. a local pro…t maximum. (Since the function is
1
quadratic, it is in fact a global pro…t maximum, but this was not required to be
shown.)
Solution 2 We have
1 1 1
f (x; y) = (x + y)2 + x + y (x + y) y
2 4 12
1 3 1
= (x + y)2 + (x + y) y
2 2 12
2
1 3 1 3
= x+y+ y
2 4 12 4
The optimum is at x = 5 and y = 3.

Exercise 2 A consumer with utility function u (x; y) = (x + 1) (y + 1) has a budget

b = 100, while the prices are px = 20, py = 40. Write down the Lagrangian for the problem
and …nd its partial derivatives. Assume that only the budget constraint is binding. Which
Lagrange multipliers must then be zero? What system of equations must be satis…ed and
what is its solution? Is the solution reasonable?

Solution 3 The Lagrangian is

L (x; y) = u (x; y) + 1 (b px x py y) + 2 x + 3 y
= (x + 1) (y + 1) + 1 (100 20x 40y) + 2x + 3y

The FOC are

@L
= (y + 1) 20 1 + 2 =0
@x
@L
= (x + 1) 40 1 + 3 =0
@y
If only the budget constraint binds, then 2 = 3 = 0 and
20x + 40y = 100
The FOC yield
y + 1 = 20 1 x + 1 = 40 1
y+1 20 1 1 1 1
= = y = (x + 1) 1= x
x+1 40 2 2 2 2

2
Substitution into the budget equation yields

1 1
20x + 40y = 20x + 40 x = 40x 20 = 100
2 2
40x = 120
x = 3
1 1 3 1
y = x = =1
2 2 2 2
The solution x = 3, y = 1 makes economic sense.
y

6.25

3.75

2.5

1.25

0
0 1.25 2.5 3.75 5 6.25 7.5

Exercise 3 A consumer with utility function u (x; y) = (x + 1) (y + 1) has a budget

b = 44, while the prices are px = 100, py = 16. Write down the Lagrangian for the problem
and …nd its partial derivatives. Assume that only the budget constraint is binding. Which
Lagrange multipliers must be then be zero? What system of equations must be satis…ed
and what is its solution? Is the solution reasonable?

Solution 4 The Lagrangian is

L (x; y) = u (x; y) + 1 (b px x py y) + 2 x + 3 y
= (x + 1) (y + 1) + 1 (44 100x 16y) + 2x + 3y

The FOC are

@L
= (y + 1) 100 1 + 2 =0
@x
@L
= (x + 1) 16 1 + 3 =0
@y
If only the budget constraint binds, then 2 = 3 = 0 and

20x + 40y = 100

The FOC yield

y + 1 = 100 1 x + 1 = 16 1
y+1 100 25 25 25 21
= = y= (x + 1) 1= x+
x+1 16 4 4 4 4

3
Substitution into the budget equation yields
25 21
100x + 16y = 100x + 16 x+ = 200x + 84 = 44
4 4
200x = 40
1
x =
5
25 1 21 5 21 16
y = + = + = =4
4 5 4 4 4 4
The solution x = 1=5, y = 4 does not make economic sense because x < 0.
y 7.5 y

3.75
6.25

2.5
5

1.25 3.75

0 2.5

0 1.25 2.5 3.75

-0.6 -0.4 -0.2 0 0.2
x
x

Exercise 4 What is the consumer optimum in the last exercise?

Solution 5 The consumer does not want to consume commodity x because it is too
expensive, so x = 0 and from the budget constraint y = 44=16 = 11=4 = 3:75. This …ts
with the Lagrangian approach: The buget equation holds per construction. The Lagrange
multiplier 3 for the constraint y 0 can be set to zero. The FOC
@L
= (y + 1) 100 1 + 2 =0
@x
@L
= (x + 1) 16 1 =0
@y
give for x = 0; y = 11=4: 1 = 1=16 0 when we use the second equation and
11 100 5
2 = +1 + = 0
4 16 2
when we use the …rst. Thus, provided x = 0; y = 11=4 is indeed the maximum of the
Lagrangian for the values of the Lagrangre multipliers just calculated, we have solved the
constrained optimization problem.

Exercise 5 The highway department is planning to build a picnic area for motorists
along a major highway. It is to be rectangular with an area of 5; 000 square yards and is
to be fenced o¤ on the three sides not adjacent to the highway. What is the least amount
of fencing that will be needed to complete the job?
a) Identify this problem as a constraint optimization problem. What objective function
f (x; y) is to be maximized / minimized subject to what constraint g (x; y) 0?
b) Write down the Lagrangian L (x; y) for this problem.
c) Find the solution to the three equations a) @L@x
= 0 b) @L
@y
= 0 c) g (x; y) 0.

4
Solution 6 a) Let x denote the length of the side of the rectangle adjacent to the highway
and let y denote the length of the other side. Then we have to minimize the amount of
fencing x + 2y subject of the constraint that the area xy is at least 5000 (xy 5000).
Equivalently, we have to maximize x 2y subject to the constraint xy 5000 0.
b) The Lagrangian is
L (x; y) = x 2y + (xy 5000)
c)
@L
= 1+ y =0 or 1= y
@x
@L
= 2+ x=0 or 2= x
@y
5000 = xy
Division of the two equations on the right yields 1
2
= xy = xy or x = 2y. Hence 5000 =
xy = 2y 2 , y 2 = 2500, y = 50 (since the solution 50 does not make sense). We obtain
x = 100, y = 50 and = 1=50 0.

Exercise 6 A consumer has the following utility when he consumes x units of apples and
y units of oranges:
u (x; y) = x2 + 4x y 2 + 16y
Suppose the consumer has a budget of £ 3.20 to be spend on oranges and apples. Each
apple and each orange costs £ 0.40. Use the method of Lagrange to …nd the optimal
consumption bundle:
a) Write down the budget constraint and the Lagrangian. Assume that only the budget
constraint is binding.

Solution 7 a) With the given prices and budget the budget constraint is
0:4x + 0:4y = 3:2.
The Lagrangian for the constrained utility maximization problem is hence
L (x; y) = u (x; y) + [3:2 0:4x 0:4y] + 2 x + 3 y
= x2 + 4x y 2 + 16y + [3:2 0:4x 0:4y]
since 2 = 3 = 0 by the complementarity conditionsb) In the optimum the two partial
derivatives of the Lagrangian must be zero:
@L
= 2x + 4 [0:4] = 0 or 2x + 4 = 0:4
@x
@L
= 2y + 16 [0:4] = 0 or 2y + 16 = 0:4
@x
Division of the two equations on the right yields
2x + 4 0:4
= =1 or 2x + 4 = 2y + 16 or
2y + 16 0:4
2x 12 = 2y or y =x+6

5
Thus y = x + 6 must hold at the constrained utility maximum.
c) In addition, the constraint
3:2
0:4x + 0:4y = 3:2 or x+y = =8 or
0:4
y = 8 x

must hold at the optimum. Overall y = x + 6 and y = 8 x must hold, so

x+6=8 x or 2x = 2 or x=1

Moreover, x = 1 implies y = 8 x = 7. Thus the Lagrangian approach suggests that it

is optimal for the consumer to buy one apple and seven oranges. (Notice that we obtain
0:4 = 16 2y = 16 14 = 2 > 0 for the Lagrange multiplier.)