EC3120 - Mathematical Economics - 2013 Exam - Zone-A

~~EC3120 ZA d0
This paper is not to be removed from the Examination Halls
UNIVERSITY OF LONDON EC3120 ZA
BSc degrees and Diplomas for Graduates in Economics, Management, Finance and the
Social Sciences, the Diplomas in Economics and Social Sciences and Access Route
Mathematical Economics
Wednesday, 29 May 2013 : 10.00am to 1.00pm
Candidates should answer EIGHT of the following TEN questions: all FIVE from Section A (8
marks each) and any THREE from Section B (20 marks each). Candidates are strongly
advised to divide their time accordingly.
Workings should be submitted for all questions requiring calculations. Any necessary
assumptions introduced in answering a question are to be stated.
If more questions are answered than requested, only the first answers attempted will be counted.
PLEASE TURN OVER
© University of London 2013

UL13/0049 Page 1 of 5 D1
SECTION A
Answer ALL questions from this section (8 marks each).
1. Answer all parts of this question.
(a) Given a constrained optimisation problem (COP) with the constraint parameter k, define the
maximum value function.
(b) A household has utility . It has strictly positive income y and faces prices
. Compute the maximum value function for the utility maximisation problem.
(a) Define a quadratic form on Rn.
(b) When do we say that a quadratic form is negative definite?
(c) Check the definitess of .
(a) Define a homothetic function.
(b) State whether the following functions are homothetic:
i.
ii. , with a,b > 0
4. Answer all parts of this question:
(a) For the following ordinary differential equation, find the solution which satisfies the given initial
conditions:
, with
(b) For the following non-homogeneous ordinary differential equation, find the general solution:

UL13/0049 Page 2 of 5 D1
5. Consider a macroeconomic control problem:
where a,r,b >0.
(a) Set up the current value Hamiltonian. Write down the necessary conditions for a maximum.
(b) Eliminate u(t) to obtain a system of first order linear differential equations in x and the co-state
variable. Compute explicitly the family of solutions to the system. How many dimensions does
this family have?
(c) Impose the transversality condition to explicitly find the subfamily of solutions consistent with
the optimality principle.

UL13/0049 Page 3 of 5 D1
SECTION B
Answer THREE questions from this section (20 marks each).
6. A consumer has an income m and a utility function of the form u(x 1 ,x 2 ) = αln x 1 +(1-α)ln x 2 , with
.
(a) If the prices of the two goods are given by p 1 and p 2 , derive the Hicksian (or compensated)
demand functions for a given utility level u.
(b) Derive the expenditure function.
(c) Using one of the duality identities, derive the indirect utility function.
(d) By using Roy's identity, determine the Marshallian demands and verify that
.
7. A firm uses labour, l, and capital, k, to produce its output. The production function is
, with a, b >0. The firm operates competitively in both the output good market and
the input factor markets: the price of a unit of output in the market is p = 1; the price of capital is r and
the price of labour is w. The firm cannot use more than units of capital and cannot buy negative
quantities of either capital or labour.
(a) Write the above as a constrained optimisation problem.
(b) Determine the conditions on the parameters under which the Kuhn-Tucker theorem applies.
(c) Under the restriction in (b), solve the problem by using the Kuhn-Tucker conditions.
8. In a model of economic growth, capital K = K(t) and consumption C = C(t) satisfy the pair of
differential equations,
where AKα is the economy’s output for capital K and r is the interest rate.
(a) If A = 4, α = 0.5 and r = 0.1, draw the phase diagram.
(b) Verify that the origin (K,C) = (0,0) is a steady-state. Find all other steady-states of the model.
(c) Linearise around each of the steady-state(s) other than the one at (0,0).
(d) Hence determine whether the steady-state(s) considered in (c) is(are) stable or unstable. What
can you say about the steady-state at (0,0)?

UL13/0049 Page 4 of 5 D1
9. An infinitely living individual has the following Cobb-Douglas technology to produce output Y t from
capital K t and labour l t ,
Yt = K tα lt1−α
where 0 < α < 1. The output at time t is then divided into consumption at t, C t , and new capital at t+1,
K t+1 , i.e.,
K t +1 = Yt − C t .
The lifetime utility of the individual is given by,
∞
∑ δ u(C , l )
t =0
t
t t
where 0 < δ < 1 is the discount factor.
(a) Noting that there are two control variables C t and l t at time t, set up the Bellman equation.
(b) Derive the inter-temporal Euler equation for the individual’s consumption.
(c) Assume now that u (C t , lt ) = ln C t + γ ln (1 − lt ) , where 0 < γ is the parameter of the utility
function. By making a guess about the functional form of V(K t , t),
i. Show that, for all t, the optimal consumption C t* is a fixed proportion of the output Y t .
ii. What can you say about the optimal labour supply lt* ?
(d) Derive the policy functions for C t and l t in terms of α, γ, δ and K t . For what value of α would the
individual consume exactly one half of his output?
10. A firm has received an order for B units of product to be delivered by time T. It seeks a production
schedule for filling this order. If x(t) denotes the inventory accumulated by time t, therefore x(0) = 0
and x(T) = B. The production rate, u(t), is the rate of change in the inventories, . The firm
incurs two costs: the cost of production and the cost of holding inventory. The unit production cost
rises linearly with the production rate and is given by αu(t); the total production cost at any moment t
is therefore this unit cost multiplied by the level of production, αu2(t). The unit cost of holding
inventory per unit time is constant and is given by β; the total inventory cost at any moment t is
therefore βx(t). α and β are both strictly positive. The firm’s total cost at any moment t is therefore
given by,
C (t ) = αu 2 (t ) + βx(t )
(This problem is analysed in Kamien and Schwartz (1991).)

(a) If the production plan is to produce at a uniform rate, namely u(t) = B/T, compute the total cost
incurred for producing B.
(b) If the firm aims to seek a production plan that minimises the total cost, set the firm’s problem as
a dynamic optimisation problem. Which are the control and state variables?
(c) Set up the Hamiltonian. Hence solve for the optimal production rate u(t) and the resulting
inventory schedule x(t) for all 0 ≤ t ≤ T, given that B ≥ βT2/4α.
(d) Briefly comment on what you would expect the firm to do when B < βT2/4α. You do not need to
solve for the optimal solution. Give the intuition behind your answer.
END OF PAPER

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~~EC3120 ZA d0

This paper is not to be removed from the Examination Halls

UNIVERSITY OF LONDON EC3120 ZA

Wednesday, 29 May 2013 : 10.00am to 1.00pm

PLEASE TURN OVER

© University of London 2013

Answer ALL questions from this section (8 marks each).

1. Answer all parts of this question.

2. Answer all parts of this question.

(a) Define a quadratic form on Rn.

(b) When do we say that a quadratic form is negative definite?

(c) Check the definitess of .

3. Answer all parts of this question.

(a) Define a homothetic function.

(b) State whether the following functions are homothetic:

ii. , with a,b > 0

4. Answer all parts of this question:

© University of London 2013

where a,r,b >0.

© University of London 2013

Answer THREE questions from this section (20 marks each).

(b) Derive the expenditure function.

(a) Write the above as a constrained optimisation problem.

(a) If A = 4, α = 0.5 and r = 0.1, draw the phase diagram.

© University of London 2013

where 0 < δ < 1 is the discount factor.

(This problem is analysed in Kamien and Schwartz (1991).)

© University of London 2013

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