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# Problem set 2

## Due Monday 2nd March 12 noon

Question 1 [20 marks]
1.1 Consider a Cobb-Douglas Utility given by (, ) = 1/4 3/4, a customer has a
budget constraint given by 2 + 3 = 10. Suppose (, ) = (, ) is another utility
function. Write down an expression for (, ) and argue whether or not (, )

(, ) = + [2marks]
(, ) (, ).[2marks]
1.2 Solve the maximization problem
max (, ) . . 2 + 3 = 10 . [10 marks]
,

(, , ) =

+ ( + )[]

= [2 marks]

= [2 marks]

= + [ ]

= , = [1marks each]
1.3 Suppose you are to maximize
max (, ) . . 2 + 3 = 10
,

out) [2 marks]

= , = [1 mark each].

## Since both (, ) (, ) represent the same preferences the solution to both

maximization problems under the same budget constraint should be equal.
[4marks]

Question 2 [20marks]
2.1Katty likes to consume a bottle of coke () with half a loaf of bread (). If she had 2
bottles of coke and 3 loaves of bread the remaining two loaves will go to waste. For this

reason her utility function is given by (, ) = min(2 , ). A loaf of bread sells for
while a bottle of coke sells for . Assume that katty has only Rm (m rands). Write an
equation that represents kattys budget line? [4 marks]
= + [4marks]
2.2 Find kattys optimal consumption bundle. [12 marks]
The optimality condition is given by

= []

## Solving this simultaneously with the budget constraint yields

=
[]
+

=
[]
+
2.3 If katty has R20 and = 10 while = 5 how many units of coke and bread will be
in kattys optimal consumption bundle.
This requires simple substitution to yield = , = [ ]
Question 3[20marks]
Phiwe a utility maximizing consumer has the following utility function for Ferrari
California (denoted ) and audi A8 (denoted ): (, ) = 4 + . Ferrari goes for R2m
per unit while Audi goes for R1m per unit.
3.1 Calculate the marginal utility of [4 marks]

= []

=
= []

3.2 Assume Phiwe has R6m to spend on cars, given the prices calculate the marginal
rate of transformation of Ferrari for Audi. (Hint: You should think about what Thabo can
afford) [4 Marks]
Markets MRT is the relative price. The budget constraint is + =
[2marks]

= []

## Or using the budget constraint = then calculate which gives similar

result.
=

3.3 By setting MRT equals MRS and the condition that Phiwes optimal choice must lie
on the budget line is it possible to predict how many units of Phiwe will
No[2marks]
MRT and MRS are constant so that equating MRS and MRT yields no meaningful
result. This is so since the goods are perfect substitutes [3marks].
3.3 Now find the optimal bundle by calculating

and

[5 marks].

= = []

= = []

Since

<

+ =
+ =
= []