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    Quiz3 - Section001 Solution 140316

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    kofi koomson
    This document contains the answer key for a microeconomics quiz. 1) It verifies that two lotteries, A and B, have the same expected value but different variances, with lottery A having a higher variance. It also shows that lottery B has a higher expected utility based on a given utility function. 2) For a production function of Q = 50ML, it is shown to have constant returns to scale. The marginal product of labor is diminishing but never negative.

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    Quiz3 - Section001 Solution 140316

    Uploaded by

    kofi koomson
    51 views2 pages
    This document contains the answer key for a microeconomics quiz. 1) It verifies that two lotteries, A and B, have the same expected value but different variances, with lottery A having a higher variance. It also shows that lottery B has a higher expected utility based on a given utility function. 2) For a production function of Q = 50ML, it is shown to have constant returns to scale. The marginal product of labor is diminishing but never negative.

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    This document contains the answer key for a microeconomics quiz. 1) It verifies that two lotteries, A and B, have the same expected value but different variances, with lottery A having a higher variance. It also shows that lottery B has a higher expected utility based on a given utility function. 2) For a production function of Q = 50ML, it is shown to have constant returns to scale. The marginal product of labor is diminishing but never negative.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    51 views2 pages

    Quiz3 - Section001 Solution 140316

    Uploaded by

    kofi koomson
    This document contains the answer key for a microeconomics quiz. 1) It verifies that two lotteries, A and B, have the same expected value but different variances, with lottery A having a higher variance. It also shows that lottery B has a higher expected utility based on a given utility function. 2) For a production function of Q = 50ML, it is shown to have constant returns to scale. The marginal product of labor is diminishing but never negative.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 2

    QUEEN ’ S U NIVERSITY, E CONOMICS D EPARTMENT

    Quiz 3 - Answer Key

    ECON 212 - Microeconomic Theory I - Winter 2016 - Section 1

    Question 1
    Consider two lotteries, A and B. With lottery A, there is a 0.90 chance that you receive a payoff
    of $0 and a 0.10 chance that you receive a payoff of $400. With lottery B, there is a 0.5 chance
    that you receive a payoff of $30 and 0.50 chance that you receive a payoff of $50.

    a. Verify that these two lotteries have the same expected value but that the lottery A
    has a bigger variance than lottery B.

    E [A] = 0.90 £ $0 + 0.10 £ $400 = 40 (1)


    E [B ] = 0.50 £ $30 + 0.50 £ $50 = 40 (2)
    2 2
    V ar [A] = 0.90 £ [$0 ° E [A]] + 0.10 £ [$400 ° E [A]] (3)
    2 2
    = 0.90 £ [$0 ° 40] + 0.10 £ [$400 ° 40] = 14, 400 (4)
    2 2
    V ar [B ] = 0.50 £ [$30 ° E [B ]] + 0.50 £ [$50 ° E [B ]] (5)
    = 0.50 £ [$30 ° 40]2 + 0.50 £ [$50 ° 40]2 = 100 (6)
    (7)

    p
    b. Suppose that your utility function is U = I + 500. Compute the expected utility
    of each lottery. Which lottery has the highest expected utility? Why?
    p p
    E [U (A)] = 0.90 £ $0 + 500 + 0.10 £ $400 + 500 = 23.1246 (8)
    p p
    E [U (B )] = 0.50 £ $30 + 500 + 0.50 £ $50 + 500 = 23.2369 (9)

    1
    Lottery B has the highest expected utility, because it is the lottery with the lowest variance. Since
    the utility function exhibits risk aversion properties and the lotteries have the same expected
    values, the consumer will prefer the lottery with the smallest variance.

    Question 2
    A firm produces a quantity
    p Q of breakfast cereal using labour L and material M with produc-
    tion function Q = 50 M L.

    a. Are the returns to scale increasing, constant or decreasing for this production
    function?
    1 1
    We can rewrite the production function as Q = 50M 2 L 2 .

    If we increase all input quantities, that is M and L, by the same proportional amount ∏, where
    ∏ > 1, and let Q 2 denote the resulting volume of output, we get:
    1 1
    Q 2 = 50(∏M ) 2 (∏L) 2 (10)
    1 1 1 1
    Q 2 = 50∏ M ∏ L
    2 2 2 2 (11)
    1 1
    Q 2 = ∏50M L = ∏Q
    2 2 (12)

    Since the exponents on ∏ sum to 1, the production function exhibits constant returns to scale.

    b. Is the marginal product of labour ever diminishing for this production function?
    If so, when? It is ever negative, and if so, when?
    The marginal product of labour is:

    @Q 1 1
    = 25M 2 L ° 2 (13)
    @L
    @2Q 25 1 3
    2
    = ° M 2 L° 2 < 0 (14)
    @L 2
    Since the partial derivative of the marginal product of labour is negative, we can conclude that
    the marginal product of labour is diminishing for the whole range of possible values of L. The
    marginal product of labour is never negative.

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