MATH96011 Mathematics of Business and Economics
Mathematics of Business and Economics
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MATH96011
Mathematics of Business and Economics
SUBMIT YOUR ANSWERS AS SEPARATE PDFs TO THE RELEVANT DROPBOXES ON
BLACKBOARD INCLUDING A COMPLETED COVERSHEET WITH YOUR CID NUMBER,
QUESTION NUMBERS ANSWERED AND PAGE NUMBERS PER QUESTION.
Date: Friday, 28 May 2021
Time: 09:00 to 11:00
Time Allowed: 2 hours
Upload Time Allowed: 30 minutes
This paper has 4 Questions.
Candidates should start their solutions to each question on a new sheet of paper.
Each sheet of paper should have your CID, Question Number and Page Number on the
top.
Only use 1 side of the paper.
Allow margins for marking.
Any required additional material(s) will be provided.
Credit will be given for all questions attempted.
Each question carries equal weight.
1. (a) State the consumer-side analogue notions to the following:
(i) Profit maximisation problem
(ii) Production function
(iii) Cost function
(iv) Marginal rate of technical substitution
(v) Conditional factor demand function
(vi) Isoquant (6 marks)
(b) Decide if the following statements are true or false. Justify your answers.
(i) The market demand curve for heroin is extremely inelastic. The market is monopolised by
the Mafia and the Mafia is only interested in maximising their profits. The two statements
are consistent with one another. (2 marks)
(ii) A firm may be willing to accept losses in the short-run. (2 marks)
(iii) Ordinal utility is a much weaker notion than cardinal utility. (2 marks)
(c) (i) Briefly explain a U-shaped long-run average cost curve in terms of the scale behaviour.
(3 marks)
(ii) Using your answer from part (c) (i), prove that there is no homogeneous production
function (of any degree k ∈ R) that gives a U-shaped long-run average cost curve.
(5 marks)
MATH96011 Mathematics of Business and Economics (2021) Page 2
2. Consider a firm that produces a single output using two input factors. The production function is
given by:
f(x1, x2) = x1x2.
Assume that the output price p and the input prices w1, w2 are all positive.
(a) Compute the elasticity of scale of f and comment on it. (2 marks)
(b) Compute the conditional factor demand function x∗(w1, w2, y) and the cost function
c∗(w1, w2, y). (3 marks)
(c) Verify Shephard’s Lemma. (1 mark)
(d) Verify that the conditional factor demand function and the cost function in (b) satisfy the
required homogeneity properties. (2 marks)
(e) Compute the optimal output y∗(p, w1, w2) and the profit function pi∗(p, w1, w2). (4 marks)
(f) Check if the conditions for the profit-maximising output are satisfied. (4 marks)
(g) Briefly explain what is the expected shape of the marginal cost curve and the average cost
curve and why it does not agree with the results in the section “geometry of costs”. (You are not
asked to sketch a graph.) (4 marks)
MATH96011 Mathematics of Business and Economics (2021) Page 3
3. (a) (i) Determine the relation between the Weak Axiom of Profit Maximisation and the Weak
Axiom of Cost Minimisation. (2 marks)
(ii) Determine the relation between the utility maximisation and expenditure minimisation.
(2 marks)
(b) Consider the following preference relation on R2: for any x = (x1, x2) ∈ R2 and
y = (y1, y2) ∈ R2 it holds that x y if and only if
x1 ≥ y1 and x2 ≥ y2.
(i) Check whether completeness, transitivity, weak/strong monotonicity, local nonsatiation,
and (strict) convexity are satisfied giving a counterexample or a proof. (8 marks)
(ii) Suppose there is a utility function u : R2 → R representing . Show that u is an injection.
(3 marks)
(c) Consider the following possible assumptions made to solve a cost-minimisation problem:
(i) the second order necessary condition holds at all points,
(ii) the production function is quasi-concave,
(iii) the production function is strictly quasi-concave,
(iv) the second order sufficient condition holds at all points.
Briefly explain the advantage of making assumption (ii) instead of (i); assumption (iii) instead
of (ii); and assumption (iv) instead of (iii). (5 marks)
MATH96011 Mathematics of Business and Economics (2021) Page 4
4. (a) Give examples of economic activities that:
(i) are not included in the Gross Domestic Product. (1 mark)
(ii) are not included in the Gross National Product. (1 mark)
(b) Suppose the economy is described by the five-sector model.
(i) Describe the equilibrium in the model and define the notation used. (2 marks)
(ii) Describe what happens if injections exceed leakages over a given time period.
(4 marks)
(c) Consider the oil market. There are n consumers, each having the same utility function, which
leads to the following market demand (measured in thousands of barrels):
X∗(p) =
n
(
a−p
2
)
, 0 ≤ p < a,
0, p ≥ a,
where p ≥ 0 is the oil price in pounds per barrel and a > 0 constant.
There are also m firms producing oil in a perfect competition and each of the firms has a
long-run cost function (reflecting the actual economic costs) c∗(y) = y(b+ y), where y ≥ 0
is the firm’s output in thousands of barrels and b ∈ (0, a) constant.
(i) Compute the individual supply function and use it to compute the market supply, Y ∗(p).
(Note: You do not have to check the second order condition.) (3 marks)
(ii) Can an individual firm ever have negative profit? Explain briefly. (2 marks)
(iii) Sketch a graph of the market demand curve and the market supply curve and compute
the equilibrium price, p∗ and the equilibrium quantity, q∗. (3 marks)
(iv) Using the graph from part (c) (iii), show graphically and justify what happens to the
market equilibrium (p∗, q∗) when (i) n increases while m is held constant; (ii) m increases
while n is held constant. (It would be preferable to draw one graph for each case.)
(4 marks)
MATH96011 Mathematics of Business and Economics (2021) Page 5
1. (a) State the consumer-side analogue notions to the following:
(i) Profit maximisation problem
(ii) Production function
(iii) Cost function
(iv) Marginal rate of technical substitution
(v) Conditional factor demand function
(vi) Isoquant
SOLUTION: (SEEN)
(i) Utility maximisation problem
(ii) Utility function
(iii) Expenditure function
(iv) Marginal rate of substitution
(v) Hicksian demand
(vi) Indifference curve (6 marks)
(b) Decide if the following statements are true or false. Justify your answers.
(i) The market demand curve for heroin is extremely inelastic. The market is monopolised by
the Mafia and the Mafia is only interested in maximising their profits. The two statements
are consistent with one another.
(ii) A firm may be willing to accept losses in the short-run.
(iii) Ordinal utility is a much weaker notion than cardinal utility.
SOLUTION: (UNSEEN/SEEN/SEEN)
(i) False. A monopolist can only maximise their profits when faced with an elastic market
demand curve. (2 marks)
(ii) True. A firm may be willing to accept losses in the short-run, because there are fixed
costs in the short-run, while in the long-run all inputs may vary. (2 marks)
(iii) True. Ordinal utility is a much weaker notion than cardinal utility because it only requires
that the consumer be able to rank goods in the order of his/her preference. (2 marks)
(c) (i) Briefly explain a U-shaped long-run average cost curve in terms of the scale behaviour.
SOLUTION: (UNSEEN)
A downward-sloping long-run average cost curve shows increasing returns to scale, a flat
long-run average cost curve shows constant returns to scale, and an upward-sloping long-run
average cost curve shows decreasing returns to scale. (3 marks)
(ii) Using your answer from part (c) (i), prove that there is no homogeneous production
function (of any degree k ∈ R) that gives a U-shaped long-run average cost curve.
SOLUTION: (UNSEEN)
A homogeneous function has f(tx) = tkf(x) for some k ∈ R. We differentiate wrt t:
MATH96011 Mathematics of Business and Economics (2021) Page 2
n∑
i=1
∂f(tx)
∂xi
xi = ktk−1f(x)
If we set t = 1, we get:
n∑
i=1
∂f(x)
∂xi
xi = kf(x)⇒ e(x) = k
where e(x) is the local elasticity wrt the scale at x. Since e(x) = k is a constant, we either
have k > 1, which implies increasing returns to scale everywhere, or k = 1, which implies
constant returns to scale everywhere or k < 1, which implies decreasing returns to scale
everywhere, so none of these gives a typical U-shaped long-run average cost curve.
(5 marks)
MATH96011 Mathematics of Business and Economics (2021) Page 3
2. Consider a firm that produces a single output using two input factors. The production function is
given by:
f(x1, x2) = x1x2.
Assume that the output price p and the input prices w1, w2 are all positive.
(a) Compute the elasticity of scale of f and comment on it.
SOLUTION: (SEEN SIMILAR) Let (x1, x2) ∈ R2≥0. The partial derivatives are given by:
∂1f(x1, x2) = x2 , ∂2f(x1, x2) = x1.
Hence, the elasticity of scale of f at (x1, x2) is given by:
e(x1, x2) =
〈∇f(x1, x2), (x1, x2)〉
f(x1, x2)
= ∂1f(x1, x2)x1 + ∂2f(x1, x2)x2
f(x1, x2)
= 2 .
This coincides also with the degree of homogeneity and it shows us that f has increasing returns
to scale.
(2 marks)
(b) Compute the conditional factor demand function x∗(w1, w2, y) and the cost function
c∗(w1, w2, y).
SOLUTION: (SEEN SIMILAR) We determine the minimiser of w1x1 + w2x2 subject to
x1x2 = y. For y = 0, we clearly have x∗1(w1, w2, 0) = x∗1(w1, w2, 0) = 0. For y > 0, we
must have x1, x2 > 0. Hence, the constraint yields that x1 = y/x2. Substituting into the cost
function yields
w1x1 + w2
y
x1
.
This is a convex function in x1. So it suffices to consider the first order condition only. This yields
x∗1(w1, w2, y) =
(
y
w2
w1
)1/2
.
Similarly, one obtains
x∗2(w1, w2, y) =
(
y
w1
w2
)1/2
.
Finally, the cost function is given by
c∗(w1, w2, y) = w1x∗1(w1, w2, y) + w2x∗2(w1, w2, y) = 2
(
yw1w2
)1/2
.
(3 marks)
MATH96011 Mathematics of Business and Economics (2021) Page 4
(c) Verify Shephard’s Lemma.
SOLUTION: (SEEN SIMILAR) We get indeed that:
x∗1(w1, w2, y) =
∂
∂w1
c∗(w1, w2, y), x∗2(w1, w2, y) =
∂
∂w2
c∗(w1, w2, y) .
(1 mark)
(d) Verify that the conditional factor demand function and the cost function in (b) satisfy the
required homogeneity properties.
SOLUTION: (SEEN SIMILAR) We should verify that the conditional factor demand functions
are homogeneous of degree 0 in w and the cost function is homogeneous of degree 1 in w. We
get indeed that:
x∗1(tw1, tw2, y) =
(
y
tw2
tw1
)1/2
= x∗1(w1, w2, y), x∗2(tw1, tw2, y) =
(
y
tw1
tw2
)1/2
= x∗2(w1, w2, y)
c∗(tw1, tw2, y) = 2
(
t2
)1/2(
yw1w2
)1/2
= tc∗(w1, w2, y)
(2 marks)
(e) Compute the optimal output y∗(p, w1, w2) and the profit function pi∗(p, w1, w2).
SOLUTION: (UNSEEN) The profit at output y is given by:
pi(p, w1, w2, y) = py − y1/2 2(w1w2)1/2 .
We can see that – as the sum of two convex functions – it is a convex function in y. For p > 0 it
has a global minimum at the critical point y0 = w1w2p2 and diverges to infinity as y →∞. Thus,
y∗(p, w1, w2) =∞, pi∗(p, w1, w2) =∞
(4 marks)
(f) Check if the conditions for the profit-maximising output are satisfied.