Final Exam Long Questions

These questions contain multiple parts that usually touch on multiple concepts. I have
designated each concept before the question using the abbreviations and color codes below.
Each question should take roughly 30-40 minutes
Choice Theory (CT)
Utility Maximization (UM)
Cost Minimization (CM)
Special Utility Functions (SU)
Profit Maximization (PM)
Partial Equilibrium (PE)
General Equilibrium with Exchange
General Equilibrium with Production (GEP)

1. There are two consumers in an economy with preferences given by

(a) (UM) Derive each consumer’s Marshallian demand for good x (you do not need
to setup a Lagrangian, but must show all other steps)
(b) (PE) Assume I1 = I2 = 1200. Find an equation for the market demand curve for
good x.
There is a single firm producing good x with production function given by
Q = 3KL1/2

(c) (CM) Derive the contingent demands for capital and labor as a function of the
wage w, the rental rate of capital v and the firm’s output Q.
(d) (PM) Now assume K is fixed at 10 3
in the short run, the wage is w = 24 and the
rental rate of capital is v = 30. Find an equation for the firm’s short run supply
curve.
(e) (PE) Given the information in part b and d, calculate the equilibrium price of
good x.
(f) (PE) What is the firm’s profit? Would this firm want to stay in the market in
the long run?
(g) (PE) The firm’s capital doubles to K = 20 3
. Show how the equilibrium price
changes on a graph of the market supply and market demand curve (do not need
exact numbers).

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2. There are two consumers (A and B) in an economy. They have utility functions given
by
U A (x, y) = x1/4 y 3/4
U B (x, y) = x3/4 y 1/4
They begin with an initial endowment of each good

eA
x = 30

eA
y = 10

eB
x = 10

eB
y = 30

(a) (GEE) Define Pareto efficiency. Is the initial endowment Pareto efficient? Justify
your answer.
(b) (GEE) Assume prices are given by px = 2 and py = 1. Show that these are
not equilibrium prices (you may use the Cobb-Douglas shortcut for Marshallian
demands).
px
(c) (GEE) Show that the equilibrium price ratio is py
= 1.
(d) (GEE) How much does each consumer consume of each good in equilibrium? Who
consumes more x and who consumes more y? How does this compare to the initial
endowments? Explain the intuition (hint: look at the utility functions)
(e) (GEE) Consumer A’s endowment of good y increases to eA y = 90. If prices remain
at ppxy = 1, how much does each consumer want to consume of each good? What
does this imply about each consumer’s desire to trade their initial endowment?
(In other words, are there still trades that make both consumers better off at
these prices?).
(f) (GEE) Find the new equilibrium price ratio.
(g) (GEE) Return to the original numbers. A third consumer enters the market who
has utility function U C (x, y) = x. He has an endowment of eC C
x = 0 and ey = 50.
Without solving for the new price ratio directly, will the price of x relative to y
increase or decrease? Explain.

2
3. There are three consumers in an economy. Each has identical preferences that can be
represented by the utility function

U (x, y) = x + 10 ln(y)

(a) (SU) Do these consumers have convex and/or homothetic preferences? Explain
how you know.
(b) (SU) Assume that the price of y is equal to 1 and that the three consumers have
incomes given by I1 = 60, I2 = 120, I3 = 160. If the price of x is equal to 8, how
much does x each consumer consume at their utility maximizing bundle?
There are two firms that produce good x with production functions given by

Q1 = K 1/3 L2/3

Q2 = K 2/3 L1/3

(c) (CM) Assume that each firm has 27 units of capital that cannot be changed in
the short run. The market wage is w = 18 and the market rental rate of capital
is v = 1. If the price of x is 8, how much does each firm produce to maximize its
profits?
(d) (PE) Is 8 the equilibrium price of x? If 8 is not the equilibrium price, is the
equilibrium price of x above or below 8? Explain how you know by referencing
the market supply and market demand at a price of 8.
(e) (PE) Setup an equation that would allow you to solve for the equilibrium price of
x (you do not need to solve it, just set it up). For this question you may assume
that consumers 2 and 3 each consume positive quantities of x while consumer 1
consumes only y.

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4. There are two consumers (A and B) in an economy. They have utility functions given
by
U A (x, y) = x1/2 y 1/2
U B (x, y) = x1/4 y 3/4
They begin with an initial endowment of each good

eA
x = 50

eA
y = 50

eB
x = 75

eB
y = 25

(a) (GEE) If consumers could buy or sell unlimited quantities of each good at a price
of 1 (i.e. px = py = 1), how much would each consumer choose to consume? Are
these consumption bundles consistent with market clearing?
(b) (GEE) Find the equilibrium price ratio and the amounts consumed by each con-
sumer in equilibrium (I recommend plugging in the numbers first when solving
this question).
(c) (GEE) Calculate each consumer’s utility in three cases: 1) At the initial endow-
ment, 2) At the allocation you got in part (a), 3) At the allocation you got in
part (b). Explain the intuition behind the answers you get (in particular, explain
why each consumer’s utility increases or decreases as price changes)
(d) (GEE) Consumer B’s preferences change so that their utility function becomes
U B (x, y) = x3/4 y 1/4 . Without directly calculating the new equilibrium, explain
why the equilibrium price ratio will go up or down. Compared to the initial
equilibrium, is consumer A better off or worse off? Explain why without directly
calculating their utility.
(e) (GEE) Return to the original utility functions. Consumer B’s endowment of
y increases to 100. Without directly calculating the new equilibrium, explain
why the equilibrium price ratio will go up or down. Compared to the initial
equilibrium, is consumer A better off or worse off? Explain why without directly
calculating their utility.

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5. For the following questions, assume a single firm produces two goods, x and y, with
production functions
x = Lx1/3
y = Ly2/3
And there is a single consumer with utility function

U (x, y) = x1/3 y 2/3

Assume that there is enough labor for the firm to hire 2000 hours and the firm always
uses all available workers. The consumer owns the firm and receives all the profits and
provides all the labor to the firm.

(a) (GEP) Assume that the firm devotes half of the available labor to each good.
How much would it produce of each good? How much revenue would it earn?
What would its Rate of Product Transformation (RPT) be at this point?
(b) (GEP) Assume that the price ratio ppxy is equal to the RPT you found above. At
this price ratio, if the consumer maximizes utility, how much would they want
to consume? What is their MRS at this point? (hint: remember the consumer’s
income is equal to the firm’s revenue)
(c) (GEP) Find the equilibrium price ratio and the quantity of x and y produced and
sold in equilibrium (round to the nearest tenth).
(d) (GEP) The consumer’s preferences change to U (x, y) = x1/2 y 1/2 . Other things
equal, will this increase or decrease the equilibrium price ratio and the equilibrium
quantity of x relative to y? Explain how you know without directly solving.
1/2
(e) (GEP) The firm’s production function for good x changes to x = Lx . Other
things equal, will this increase or decrease the equilibrium price ratio and the
equilibrium quantity of x relative to y? Explain how you know without solving
for the new equilibrium price ratio.

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6. There are two consumers in an economy with utility functions given by

U A (x, y) = x4 y

U B (x, y) = 3 ln(x) + ln(y)

Consumer A has an income I A = 3200 and consumer B has income I B = 2048

(a) (PE) Show that the market demand for this economy is given by X D = 4096
px
. You
do not need to setup a Lagrangian but you must show all other steps in solving
for each consumer’s demand.
Assume that there are N firms in the market for x and each has production
function given by
Qx = K 1/4 L1/4
Each firm has 16 units of capital, which they cannot change. The firms pay a
wage of 4 for each unit of labor and a rental rate of 12 for each unit of capital.
(b) (PE) If N=1, what is the equilibrium price and quantity produced and sold in this
market in equilibrium in the short run (you may assume the market is perfectly
competitive even though N=1).
(c) (PE) At the equilibrium price you found in part b, would the firm be willing to
stay in the market in the long run? Using a graph of short run market supply
and demand, explain what you would expect to happen as the market shifts to
its long run equilibrium.
(d) (PE) How many firms would enter this market in the long run? What would be
the equilibrium price and quantity in the long run?

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7. There are two consumers (A and B) in an economy. They have utility functions given
by
U A (x, y) = x5/6 y 1/6
U B (x, y) = x4/5 y 1/5
They begin with an initial endowment of each good

eA
x = 100

eA
y = 20

eB
x = 100

eB
y = 20

(a) (GEE) Is the initial endowment a Pareto efficient allocation? If so, explain how
you know. If not, explain how consumers could agree to a trade that makes both
better off (a complete answer will explain which good each consumer would want
to trade and why - showing that it is not an equilibrium is not enough)
(b) (GEE) Find the equilibrium price ratio and quantity consumed of each good for
each consumer (round to the nearest tenth). Which good did each consumer trade
to the other?
(c) (GEE) If consumer B’s endowment of x was instead eB x = 80, repeat part (a)
and explain how the change in endowment would change the equilibrium price
of x relative to y (note: for parts (c)-(e), you may solve for the new equilibrium
price ratio if it helps you but you will be graded primarily on your intuitive
explanations).
(d) (GEE) Return to the original endowments. Consumer A doubles both of their
endowments. Explain how this change would change the equilibrium price of x
relative to y compared to the initial equilibrium.
(e) (GEE) Return to the original endowments. A third consumer enters the market
who has utility function U C (x, y) = x + 50y. He has an endowment of eC x = 100
C
and ey = 100. Without solving for the new price ratio directly, will the price of
x relative to y increase or decrease compared to the initial equilibrium? Explain.

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8. A fruit company owns an orchard with trees that produce apples (A) and bananas
(B). It hires workers to pick the two fruits. The amounts of each fruit that the
workers produce are given by the functions
1/2
A = LA
1/2
B = 4LB
Where LA is the number of labor hours devoted to picking apples and LB is the number
of labor hours devoted to picking bananas. The firm sells all of its apples and bananas
to a consumer who has a utility function

U (A, B) = 2A1/2 + B 1/2

There are enough workers in the economy to work 3200 hours and the firm always uses
all available workers. The consumer owns the firm and receives all profit and provides
all the labor to the firm.

(a) (UM) Derive the consumer’s Marshallian demands for apples and bananas as a
function of income and prices (you do not need to setup a Lagrangian)
(b) (GEP) If the price of A is 8 and the price of B is 1, how much will the firm produce
to maximize profit? Given the firm’s profit and these prices, how much will the
consumer choose to consume? Does the market clear? (Round to nearest tenth)
(c) (GEP) Find the equilibrium price ratio and the quantity of A and B produced
and sold in equilibrium.
1/2
(d) (GEP) The production function for apples changes to A = 4LA . If the price
ratio did not change, will there be an excess supply or demand of either good?
What will happen to prices and quantities in equilibrium (Do not need to solve
for the exact values, just explain the direction)?