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Problem3.21
EconS301

Supposeaconsumerspreferencesfortwogoodscan
berepresentedbytheCobbDouglasutilityfunction
U=Axy
whereA,,andarepositiveconstants.Themarginal
utilitiesare
MUx =Ax 1y andMUy =Axy 1.
Answerthefollowingquestions.

Problem3.21(a)

Problem3.21(b)

Istheassumptionthatmoreisbettersatisfiedforboth
goods?

Doesthemarginalutilityofxdiminish,remainconstant,or
increaseastheconsumerbuysmoreofx?Explain.

Yes,themoreisbetterassumptionissatisfiedfor

bothgoodssincebothmarginalutilitiesarealways
positive.

Sincewedonotknowthevalueof,onlythatitispositive,
weneedtospecifythreepossiblecases:
When 1,themarginalutilityofx diminishesasx
increases.
When 1,themarginalutilityofx remainsconstantasx
increases.
When 1,themarginalutilityofx increasesasx
increases.

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Problem3.21(c)

Problem3.21(d)

WhatisMRSx,y?

IstheMRSdiminishing,constant,orincreasingasthe
consumersubstitutesxforyalonganindifferencecurve?

MRS x , y

MU x Ax 1 y y

MU y Ax y 1 x

Astheconsumersubstitutesforxfory,theMRSx,y
willdiminishbecausexisinthedenominatorand
drivesdowntheentirefraction.

Problem4.2

Problem4.2(a)

TheutilityfunctionthatAnnreceivesbyconsuming
foodFandclothingCisgivenby
U(F,C)=FC+F
Themarginalutilitiesoffoodandclothingare
MUF =C+1andMUC =F
Foodcosts$1aunit,andclothingcosts$2aunit.Anns
incomeis$22.Answerthefollowingquestions.

Anniscurrentlyspendingallofherincome.Sheis
buying8unitsoffood.Howmanyunitsofclothingis
sheconsuming?
IfAnnisspendingallofherincomethen

F 2C 22
8 2C 22
2C 14
C7

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Problem4.2(b)

Problem4.2(b,cont.)

Graphherbudgetline.Placethenumberofunitsof
clothingontheverticalaxisandthenumberofunitsof
foodonthehorizontalaxis.Plothercurrent
consumptionbasket.

12

10

Clothing

Remember:UsetheBudgetLineandsetthequantityof
goody equaltozerotofindthehorizontalintercept,and
thenthequantityofgoodx equaltozerotofindthe
verticalintercept.

0
0

10

15

20

25

30

35

Food

Drawtheindifferencecurveassociatedwithautility
levelof36andtheindifferencecurveassociatedwitha
utilityof72.
Aretheindifferencecurvesbowedintowardtheorigin?

Problem4.2(c,cont.)
80
70

Yes, the indifference curves are convex,

i.e., bowed in toward the origin. Also,
note that they intersect the Faxis; a
common property in quasilinear utility
functions as the one in this exercise.

U=72

60
Clothing

Problem4.2(c)

50
40
30

U=36

20
10
0
0

10

15

20

25

30

35

Food

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Usingagraph(andnoalgebra),findtheutility
maximizingchoiceoffoodandclothing.
Thatis,findthetangencybetweenthebudgetlineand
theindifferencecurves.

Problem4.2(d,cont.)
80
70

U=72
60

Clothing

Problem4.2(d)

50
40

U=36

30

Optimum at F=12, C=5

20
10
0
0

10

15

20

25

30

35

Food

Problem4.2(e)

Problem4.2(e,cont.)

Usingalgebra,findtheutilitymaximizingchoiceoffood
andclothing.

The tangency condition requires that:

MU F PF

MU C PC

Plugging in the known information yields:

C 1 1

F
2
2C 2 F

Substituting this result into the budget line results in:

( 2C 2) 2C 22
4C 20
C 5

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Problem4.2(e,cont.)

Problem5.19

Finally, plugging this result, C=5 units, back into the

tangency condition 2C+2=F, yields
F=2(5)+2=12.
Summarizing, at the optimum the consumer
chooses:
C=5, i.e., 5 units of clothing, and
F=12, i.e., 12 units of food.

Louspreferencesoverpizza(x)andothergoods(y)are
givenby
U(x,y)=xy,
withassociatedmarginalutilities
MUx=yandMUy=x.
Hisincomeis$120.

Problem5.19(a)

Problem5.19(b)

CalculatehisoptimalbasketwhenPx=4andPy=1.

Calculatetheincomeandsubstitutioneffectsofa
decreaseinthepriceoffoodfrom$4to$3.

Usingthetangencycondition,y/x=4,andthebudget
constraint,4x+y=120,

4 x 4 x 120
8 x 120
x 15

4(15) y 120
y 60

Lousinitialoptimumisthebasket(x,y)=(15,60)witha
utilityof900.

Firstweneedtofindthedecompositionbasket.This
wouldsatisfythenewtangencycondition,y/x=3,i.e.,
y=3x.Inaddition,itwouldgivehimasmuchutilityas
beforethepricechange,i.e.xy=900.
y 3x
x (3 x ) 900
x 2 300
x 17 .32

17.32 y 900
y 51.9

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Problem5.19(b,cont.)

Problem5.19(c)

Thisgives(x,y)=(103,303 , orapproximately
(17.3,51.9).Nowweneedthefinalbasket,whichsatisfies
thesametangencyconditionasthedecomposition
basketandalsothenewbudgetconstraint,3x+y=120:

Calculatethecompensatingvariationofthepricechange.

y
3
x
y 3x
3 x 3x 120
6 x 120

3(20) y 120
y 60

x 20

Together,theseconditionsimplythat(x,y)=(20,60).
Thesubstitutioneffectistherefore17.3 15=2.3,andthe
incomeeffectis20 17.3=2.7.

Problem5.19(d)
Calculatetheequivalentvariationofthepricechange.
TheequivalentvariationistheamountofincomethatLou

wouldneedtobegivenbefore thepricechangeinordertoleave
himaswelloffashewouldbeafterthepricechange.
Afterthepricechangehisutilitylevelis20(60)=1,200.Therefore
theadditionalincomeshouldbesuchthatitallowsLouto
purchaseabundle(x,y)satisfyingtheinitialtangencycondition
withthisutility.
Thisimplies(x,y)=(103,403 , or approximately(17.3,69.2).
HowmuchincomewouldLouneedtopurchasethisbundle
undertheoriginalprices?Hewouldneed4(17.3)+69.2=138.4.
Thatis,hewouldneedtoincreasehisincomeby

ThecompensatingvariationistheamountofincomeLou
wouldbewillingtogiveupafterthepricechangeto
maintainthelevelofutilityhehadbeforethepricechange.
Thisequalsthedifferencebetweentheconsumersactual
income,$120,andtheincomeneededtobuythe
decompositionbasketatthenewprices.
Thislatterincomeequals:
3*17.3+1*51.9=103.8.
Therefore,thecompensatingvariationis
CV=120 103.8=$16.20.

Problem5.20
Carinabuystwogoods,foodFandclothingC,withthe
utilityfunction
U=FC+F
HermarginalutilityoffoodisMUf=C+1andhermarginal
utilityofclothingisMUc=F.
Shehasanincomeof$20.Thepriceofclothingis$4.

EV=138.4 120=$18.40dollars
inordertobeaswelloffasifthepriceofpizzaweretodecrease
instead.

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Problem5.20(a)
DerivetheequationrepresentingCarinasdemandforfood,anddrawthis
demandcurveforpricesoffoodrangingbetween1and6.
MUF =C+1MUC =F

Problem5.20(a,cont.)
ThefigureplotsF=12/PF.Notethat,sincethepriceisintheverticalaxis,
wefirstneedtosolveforthepricePF,whichyieldsaninversedemandfunction
PF =12/F

Demand for food

PF5
4

Tangency:MUF/MUC =PF /PC,or(C+1)/F=PF/4,implying4C+4=PFF.(Eq1)

BudgetLine:PFF+PCC=I,whichimpliesPFF+4C=20.(Eq2)

Substituting(Eq1)into(Eq2):4C+4+4C=20.ThusC=2,independentofPF.

Fromthebudgetline,weseethatPFF+4(2)=20,whichsimplifiestoPFF=12.
SolvingforFweobtainthedemandforF,

3 4

12

F=12/PF

Problem5.20(b)

Problem5.20(b,cont.)

CalculatetheincomeandsubstitutioneffectsonCarinas
consumptionoffoodwhenthepricerisesfrom1to4.
Drawagraphillustratingtheseeffects.[Yourgraphdoes
notneedtobetoscale,butitshouldbeconsistentwith
thedata.]

InitialBasket: Fromthedemandforfoodin(a),F=12/1=12,
andC=2.
Also,theinitiallevelofutilityisU=FC+F=12(2)+12=36.
FinalBasket: Fromthedemandforfoodin(a),weknowthat
F=12/4=3,andC=2.Andthefinallevelofutilityis,
U=3(2)+3=9.
DecompositionBasket:Mustbeoninitialindifferencecurve,
withU=FC+F=36
(Eq 3)

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Problem5.20(b,cont.)
Tangencyconditionsatisfiedwithfinalprice:
MUF/MUC =PF /PC.(C+1)/F=4/4=>C+1=F.(Eq 4)

Problem5.20(b,cont.)

Eq 3,FC+F=36,canbewrittenasF(C+1)=36.

IncomeeffectonF:
Ffinal basket Fdecomposition basket =3 6=3.

PluggingEq 4intotherewrittenEq 3wehave

(C+1)(C+1)=(C+1)2 =36,andthus,C=5.

SubstitutioneffectonF:
F decompositionbasket Finitial basket =6 12=6.

Also,byEq 4,C+1=F,or5+1=F,entailingF=6.
Summarizing,thedecompositionbasketisF=6,C=5.

Problem5.20(b,cont.)

Problem5.20(c)
Determinethenumericalsizeofthecompensating
variation(inmonetaryterms)associatedwiththe
increaseinthepriceofthegoodfrom$1to$4.
PFF+PCC=4(6)+4(5)=44.
Soshewouldneedanadditionalincomeof24(plusher
actualincomeof20).
Thecompensatingvariationassociatedwiththeincrease
inthepriceoffoodis 24.

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Problem5.28

Problem5.28(cont.)

ConsiderNoahspreferenceforleisure(L)andother
goods(Y),U ( L, Y ) L Y.Theassociatedmarginal
utilitiesare:

IfNoahswagerateisw,thentheincomeheearnsfrom
workingis(24 L)w.
SincePY=1,thenumberofunitsofothergoodshe
purchasesisY=(24 L)w.

MU L

1
2 L

and MU Y

1
2 Y

Also,thetangencyconditiongivesus

SupposethatPY=$1.IsNoahssupplyoflaborbackward
bending?

Combiningthetwoconditionsgivesus
or,solvingforL,
24/
1 .

.
24

Problem5.28(cont.)

Problem5.28(cont.)

Giventhattheoptimalamountofleisure(L)heconsumesis
24/
1 .

SincetheamountoflaborthatNoahsuppliesequals
24 L=24
24/
1 )=24 /
1 .
weseethathissupplyoflaboralwaysincreases withan
increaseinthewagerate,w
Hence,hislaborsupplycurveisalwayspositivelysloped
thatis,itisnotbackwardbending.
Letsplotit.

Leisuredecreases withanincreaseinthewagerate,w,and
thisistruenomatterwhatthewagerateis;asdepictedin
thenextslide.
12
10
8
6
4
2

10

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Problem6.19
AmountoflaborthatNoahsupplies,

,asafunctionofw.

A firm produces quantity Q of breakfast cereal using labor L

and material M with the production function

Q 50( ML)1/2 M L
20

The marginal product functions for this production function

are:

15

1/ 2

M
MPL 25
L

10

1/ 2

10

L
MPM 25
M

Problem6.19(a)

Problem6.19(b)

Are the returns to scale increasing, constant, or decreasing for this

production function?

Is the marginal product of labor ever diminishing for this production

function? If so, when? Is it ever negative, and if so, when?

To determine the nature of returns to scale, increase all inputs by some

factor and determine if output goes up by a factor more than, less than,
or equal to .

Q 50 ( M L )1 / 2 M L

50 1 / 2 1 / 2 ( ML )1 / 2 M L
50 ( ML )1 / 2 M L

50 ( ML )1 / 2 M L
Q

Thus, by increasing all inputs by a factor , output goes up by a factor of .

Since output goes up by the same factor as the inputs, this production
function exhibits constant returns to scale.

10

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Exercise2
A firm produces quantity Q of breakfast cereal using labor L
and material M with the production function Q 50(ML)1/ 2 M L .
The marginal product functions for this production function
are:

Answer
Dont forget,

1/ 2

M
MPL 25
L

1/ 2

M
MPL 25
L

1/ 2

L
MPM 25
M

Suppose M>0. Holding M constant, increasing L will decrease

the MPL. The marginal product of labor is decreasing for all
levels of labor. The MPL, however, will never be negative since
both components of the equation will always be greater or
equal to zero. In fact, for this production function, MPL 1.

b) Is the marginal product of labor ever diminishing for

this production function? If so, when? Is it ever
negative, and if so, when?

11