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Microeconomics 2012-2013 IBA

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Problem set 2: Chapters 4 and 5

Microeconomics 2012-2013 IBA

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CHAPTER 4: Consumer choice


Before making these exercises, you should finish Homework Week 4, Chapters 4 & 5 in
WileyPlus.

Question 4.1
A consumer gets satisfaction from consuming good x and good y according to
1

U ( x, y) 12x 4 y 4 . Take that the prices equal P = 10 and P = 20 and that his total budget
x
y

for these goods is equal to 400.


a) Write down the consumer problem (in mathematical form)
b) Determine the optimal consumption basket.

Question 4.2
The utility that Ann receives by consuming food F and clothing C is given by U(F, C) = FC +
F. Food costs $1 a unit, and clothing costs $2 a unit. Anns income is $22.
a) Ann is currently spending all of her income. She is buying 8 units of food. How many
units of clothing is she consuming?
b) Graph her budget line. Place the number of units of clothing on the vertical axis and the
number of units of food on the horizontal axis. Plot her current consumption basket.
c) Draw the indifference curve associated with a utility level of 36 and the indifference curve
associated with a utility level of 72. Are the indifference curves bowed in toward the
origin?
d) Using a graph (and no algebra), find the utility maximizing choice of food and clothing.
e) Using algebra, find the utility-maximizing choice of food and clothing.
f) What is the marginal rate of substitution of food for clothing when utility is maximized?
Show this graphically and algebraically.
g) Does Ann have a diminishing marginal rate of substitution of food for clothing? Show this
graphically and algebraically.

Microeconomics 2012-2013 IBA

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Question 4.3
Helens preferences over CDs (C) and sandwiches (S) are given by U(S,C) = SC + 10(S+C).
If the price of a CD is $9 and the price of a sandwich is $3, and Helen is spending a combined
total of $30 each days on these goods, find Helens optimal consumption basket.

CHAPTER 5: The theory of demand

Question 5.1
Let the utility of a consumer over two goods be U(x,y)=6xy. Let I=$60, Px = $1 and Py = $2
be the initial set of prices and income.
a) Is good y a normal or an inferior good?
b) Let Py rise to $3 and consider the change in the optimal consumption of good y: which of
the effects is bigger, the income or the substitution effect?

Question 5.2
Consider a quasi-linear utility function U(x,y) = ln(1+x) + y, where the prices are given by Px
and Py and income is at I. Note that dln(x)/dx = 1/x.
a) Derive the demand functions for good x and good y.
b) What is the income elasticity of both goods?

Question 5.3
Suzie purchases two goods, food and clothing. She has a utility function U(x,y)=xy, where x
denotes the amount of food consumed and y denotes the amount of clothing. The price of food
is Px, the price of clothing Py and her income I.
a) Derive the equations for the demand curve for food and the demand curve for clothing.
b) Are food and clothing both normal goods?
c) Discuss the cross price elasticity of the demand of food with respect to the price of
clothing. How does the consumer divide the income among the goods?

Microeconomics 2012-2013 IBA

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d) Now, suppose that Suzie has an income of $90 per week. Suppose that the price of food is
initially Px1=$9 per unit and that the price subsequently falls to Px2 =$4 per unit (assume
the price of clothing is 1). Find the numerical values of the income and substitution effects
on food consumption and show on a graph.
e) Instead, suppose that the price increases from Px1=$9 per unit to Px2 =$15 per unit, holding
constant the other assumptions. Find the numerical values of the income and substitution
effects on food consumption and show on a graph.

Question 5.4
Suppose that a consumers utility function is U(x,y) = xy + 10y.
a) Assume first that we are at an interior optimum. Derive the demand schedule for good x.
b) Suppose now that I = 100. Since x must never be negative, what is the maximum value of
Px for which the consumer would ever purchase any x?
c) Suppose Py=20 and Px = 20. On a graph illustrating the optimal bundle of x and y
calculated in part b, show that Px exceeds the value you calculated.
d) Compare the marginal rate of substitution of x for y with the ratio (Px/Py) at the optimum
at prices Py=20 and Px = 20. Does this verify that the consumer would reduce utility if she
purchased a positive amount of x?
e) Assuming income remains at 100, draw the demand schedule for x for all values of Px.
Does its location depend on the value of Py?

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