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Prof. Ignacio Monzon
Collegio Carlo Alberto
Fall 2011

M ICROECONOMIC T HEORY - PS #2 - A NSWER K EY
Due date: 17 Oct 2011

1. Let (B, C (•)) be a choice structure. Moreover, let C (•) be a function (that is, for all B ∈ B,
C ( B) = x for some x ∈ B). In such a case, is the following property an equivalent expression
for the weak axiom of revealed preference?
x, y ∈ B and x, y ∈ B0 

C ( B) = x ⇒ C B0 6= y

Let us denote this new property by (WA*) and the usual weak axiom by WA.
(a) We deal first with the following statement: WA ⇒ WA*.
We are told that x, y ∈ B, x, y ∈ B0 and x ∈ C ( B). Can we show that C ( B0 ) 6= y? If the
weak axiom holds, and y ∈ C ( B0 ), then also y ∈ C ( B). But we know that y 6∈ C ( B),
since C is a function. As a result, y 6∈ C ( B0 ). This implies of course that C ( B0 ) 6= y.
(b) We deal now with the following statement: WA* ⇒ WA.
The weak axiom applies when x, y ∈ B, x, y ∈ B0 and x ∈ C ( B). It requires, under those
conditions, that y ∈ C ( B0 ) ⇒ x ∈ C ( B0 ). This is equivalent to x 6∈ C ( B0 ) ⇒ y 6∈ C ( B0 ).
Since C is a function, this is equivalent to x 6= C ( B0 ) ⇒ y 6= C ( B0 ). Finally, again since
C is a function, of course if C ( B0 ) = x, then C ( B0 ) 6= y. To sum up, if C is a function,
the weak axiom requires: 

x, y ∈ B and x, y ∈ B0 C ( B) = x ⇒ C B0 6= y
which is exactly what we were trying to show.
2. MWG 1.D.3B Let X = { x, y, z} and consider the choice structure (B, C (•)) with
B = {{ x, y} , {y, z} , { x, z} , { x, y, z}}
and C ({ x, y}) = { x }, C ({y, z}) = {y} and C ({ x, z}) = {z}, as in example 1.D.1. Show that
(B, C (•)) must violate the weak axiom.
Answer: Let us do it in steps.
(a) Assume that x ∈ C ({ x, y, z}). Recall that z ∈ C ({ x, z}) and of course, x, z ∈ { x, y, z}
and x, z ∈ { x, z}. Then, by the weak axiom, x ∈ C ({ x, z}), which is false.
(b) Assume that y ∈ C ({ x, y, z}). Recall that x ∈ C ({ x, y}) and of course, x, y ∈ { x, y, z}
and x, y ∈ { x, y}. Then, by the weak axiom, y ∈ C ({ x, z}), which is false.
(c) Assume that z ∈ C ({ x, y, z}). Recall that y ∈ C ({y, z}) and of course, y, z ∈ { x, y, z}
and x, z ∈ {y, z}. Then, by the weak axiom, z ∈ C ({ x, z}), which is false.
Now, we know C ({ x, y, z}) is non-empty, so (B, C (•)) must violate the weak axiom.

xl p. 4. w) p2 w = x3 ( p.. We should verify wether x (αp. and consider the demand function x ( p. MWG 2. w) for all ( p. w) = 1 for every l. MWG 2. w). 1) w. w) defined by: p2 p1 + p2 + p3 p3 x2 ( p. w) = xl ( p. Answer:  Note that for all l. xl ( p. Then. w) = xl ( p. αw) = = αp1 + αp2 + αp3 αp3 p1 + p2 + p3 x1 (αp. Then. w) is homogeneous of degree one with respect to w [i. p2 βp1 w p3 w w + p3 + p2 p1 + p2 + p3 p1 p1 + p2 + p3 p2 p1 + p2 + p3 p3 p3 βp1 p2 w+ w+ w = p1 + p2 + p3 p1 + p2 + p3 p1 + p2 + p3 w = ( p2 + p3 + βp1 ) p1 + p2 + p3 px ( p. w) = p1 + p2 + p3 βp1 x3 ( p. w). xl ( p. αw) = αxl ( p. or more nicely.e. w) xl ( p. w). 1) w 2 . Next. draw the Engel curve for the case L = 2. w−1 w = w−1 xl ( p. Interpret.E. αw) = = αp1 + αp2 + αp3 αp2 p1 + p2 + p3 βαp1 αw βp1 x3 (αp. 1) = xl ( p. αw) = w = x1 ( p. regarding Walras’ law. αp2 αw p2 = αp1 + αp2 + αp3 αp1 p1 + p2 + p3 αp3 αw p3 x2 (αp. w) for all α > 0] and satisfies Walras’ law. Then. αw) = αx ( p. Let α = w−1 . αw) = x ( p.1A Suppose L = 3. w) xl ( p.4B Show that if x ( p. homogeneity of degree zero hols for all β. w) p3 So in fact. 1)? Answer: Let us start with homogeneity of degree zero. x ( p. w). we should verify that px ( p. Can you say something about Dw x ( p. the elasticity of demand will be one: ε wl = w w w ∂xl ( p. In this case. w) = p1 So Walras’ law only holds if β = 1.3. then ε lw ( p. w) and the form of the Engel functions and curves in this case? Also. saying that demand is homogeneous of degree one is equivalent to saying demand is linear in income. w) = p1 + p2 + p3 x1 ( p. w) p1 w = x2 ( p. In this case. w) = w p1 w p2 w p3 Does this demand function satisfy homogeneity of degree zero and Walras’ law when β = 1? What about when β ∈ (0. w) = w for all ( p. 1) =1 ∂w xl ( p.E.

Would you still pay \$10 for a ticket to the play? Consider the decision that an individual in the first group faces. The outcomes are (one ticket and M − 10 dollars) or (no ticket and M dollars) 3 . w) is constant for all w. As you enter the theater. x1 Figure 1: Engel curve for L = 2 Next. . x2 ( p. So Engel curves will be linear. As you arrive at the theater. They have no ticket. Xa = {( one ticket and M − 10 dollars ) . x L ( p. . given a fixed vector of prices. . 1)). They have some money. 1) . They have no ticket. . They have some money. Consider the decision that an individual in the second group faces. (Loosely based on Rubinstein) Consider the following example taken from Kahneman and Tversky (1984). Compare Xa and Xb . Define the set X of alternatives and denote it by Xb . Figure 1 shows the case for L = 2. 1) . Would you pay \$10 for another ticket? Members of another group were asked to answer the following question: (b) Imagine that you have decided to see a play where the admission is \$10 per ticket. They can either buy a ticket and spend \$10 or not buy the ticket. Members of one group of subjects were presented with the following question: (a) Imagine that you have decided to see a play and paid the admission price of \$10 per ticket. Define the set X of alternatives and denote it by Xa . Let M denote the amount of money they have. Let M denote the amount of money they have. Dw x ( p. That is. Then. you discover that you have lost a \$10 bill. They can either buy a ticket and spend \$10 or not buy the ticket. Analyze the possible outcomes. note Dw x ( p. What is your prediction about the behavior of people in each group.x2 ¯ w) x ( p. w) = ( x1 ( p. Analyze the possible outcomes. The outcomes are (one ticket and M − 10 dollars) or (no ticket and M dollars) respectively. The seat was not marked and the ticket cannot be recovered. 5. Is that behavior consistent with rationality? Why? Answer: Let us start with people in the first group. ( no ticket and M dollars )} Let us continue with the second group. you discover that you have lost the ticket.

Regarding how people actually behaved. Then. If you don’t. but 88% bought a ticket after being told they had lost a \$10 bill.hk/˜mark551/readings/T4cR4_kahneman1984. Xa = Xb .ust. http://www. have in mind that in the experiment. ( no ticket and M dollars )} Consequently.bm.respectively.pdf 4 . only 46% bought another ticket. Xb = {( one ticket and M − 10 dollars ) . you might want to take a look at the original paper.