HUL 212A: Microeconomics
IIT Delhi
Problem Set 4
March 15, 2026
1. Examples of markets
a. Consider a market in which some individual initially owns his favorite house.
Show that in any equilibrium this individual is allocated this house.
b. What can you say about the equilibrium allocation in a market equilibrium in
which every house has a different price?
c. Show that in an equilibrium of any market consistent with the following table,
individual 4 is allocated his favorite house.
Individual
1 2 3 4
Initial allocation D C B A
Favorite house A A D ?
2. Give an example of a market for which removing one of the individuals, together with
the house he initially owns, makes one of the remaining individuals better off and
another of the remaining individuals worse off.
3. Effect of changes in one individual’s preferences.
a. Let M1 be a market and let (p, a) be an equilibrium of M1 . Assume that M2
differs from M1 only in that a(1) moves up in individual 1’s preferences. What
can you say about the equilibrium allocations in the two markets?
b. In the market M1 , individual 1 initially owns house A. The market M2 differs
from M1 only in that in M2 the ranking of A in individual 2’s preferences is higher
than it is in M1 . Show that individual 1 is not worse off, and may be better off,
in the equilibrium of M2 than in the equilibrium of M1 .
4. Consider a simple competitive economy with one consumer and one firm. The con-
sumer’s preferences over consumption C and leisure R are given by
u(C, R) = log C + log R.
1
The consumer has a time endowment T . If the consumer supplies L units of labor,
then leisure is
R = T − L.
The consumer earns wage income wL and receives the firm’s profits π. The price of the
consumption good is p. The firm produces the consumption good using labor according
to the production function
f (L) = AL1/2 , A > 0.
Markets are competitive and agents take prices as given.
(a) Write the consumer’s utility maximization problem and derive the first-order con-
ditions. Obtain expressions for the consumer’s demand for consumption and
leisure.
(b) Write the firm’s profit maximization problem and derive the firm’s labor demand.
(c) Define a competitive equilibrium for this economy.
(d) Derive the equilibrium real wage and the equilibrium quantity of labor.
(e) Determine equilibrium consumption and profits.
(f) Verify that the equilibrium satisfies goods market clearing and briefly explain the
role of diminishing returns in determining equilibrium labor demand.
Definition 1 (Jungle Equilibrium). A jungle equilibrium is a feasible allocation z for
which there does not exist an ordered pair of agents i, j, bilateral takings y i,j , and a
feasible bundle
ẑ i = z i + y i,j ∈ C i
such that
ẑ i ≻i z i .
5. Consider an economy with two agents i = 1, 2 and two goods. The total endowment is
ω̃ = (2, 1).
The consumption sets are identical and given by
C 1 = C 2 = {x ∈ R2+ | x ≤ ω̃}.
Both agents have Leontief preferences
ui (xi1 , xi2 ) = min{xi1 , xi2 }, i = 1, 2.
Consider the following allocations:
ω 1 = (1, 1), ω 2 = (1, 0), ω 3 = (0, 0),
and
ω 1 = (1, 1), ω 2 = (0, 0), ω 3 = (1, 0).
Show that both allocations are equilibria with bilateral takings (i.e., no agent can
improve through bilateral deviations). Briefly explain the intuition.
Page 2
6. Consider an economy with two agents i = 1, 2 and three goods. The total endowment
is
ω̃ = (1, 1, 1).
The agents’ consumption sets are identical and given by
C 1 = C 2 = {x ∈ R3+ | x ≤ ω̃}.
Both agents have Leontief preferences
ui (xi1 , xi2 , xi3 ) = min{xi1 , xi2 , xi3 }, i = 1, 2.
(a) Determine the lexicographic welfare maximizing allocation.
(b) Show that for α ∈ [0, 1], the allocation
ω 1 = (1, α, α), ω 2 = (0, 1 − α, 0), ω 3 = (0, 0, 1 − α)
is an equilibrium with bilateral takings.
(c) Show that when α < 1, the allocation is Pareto inefficient by constructing a Pareto
improvement.
(d) Briefly explain why, up to permutations of goods, no other equilibria exist.
7. Consider an exchange economy with two agents i = 1, 2 and two goods. The total
endowment of the economy is
ω̃ = (2, 1).
Each agent has the same consumption set
C 1 = C 2 = x ∈ R2+ | x ≤ ω̃ .
Agent 1 has Leontief preferences represented by
u1 (x11 , x12 ) = min{x11 , x12 },
while Agent 2 has preferences represented by
q q
2 2
u2 (x1 , x2 ) = x1 + x22 .
2
Let z = (z 1 , z 2 , z 3 ) denote an allocation where z 1 and z 2 are the consumption bundles
of agents 1 and 2, respectively, and z 3 represents any unallocated endowment.
(a) Determine the utility-maximizing bundle of Agent 1 in C 1 .
(b) Determine the utility-maximizing bundle of Agent 2 in C 2 .
(c) Show that the set of lexicographic welfare maximizers is given by
n o
Z̄ = (z 1 , z 2 , z 3 ) ∈ C 1 × C 2 × ω̃ z 1 = (1 + ε, 1), z 2 = (1 − ε, 0), z 3 = (0, 0), ε ∈ [0, 1] .
(1)
Page 3
(d) Explain why this set coincides with the set of jungle equilibria as well as the set
of farsighted equilibria. (Ignore for now)
(e) Show that for ε > 0, the lexicographic welfare maximum is Pareto inefficient by
constructing a Pareto-improving allocation.
(f) For which value of ε is the allocation Pareto efficient? Explain.
(g) Provide an economic interpretation of withholding in this economy and explain
why it occurs whenever ε > 0.
Page 4