Econ 125a, Fall 2010

Problem Set 2
Due on Wednesday, September 22 at the beginning of class

1. Bob consumes ice cream cones (x1 ) and hamburgers (x2 ) . His utility function is

u (x1 , x2 ) = ln x1 + ln x2 .

Bob’s income is $ 50. The price of each hamburger is $ 2. The price of an ice cream
cone depends on the quantity that Bob consumes. Specifically, he can buy the first ten
ice cream cones at the price of $ 2 each. For each additional ice cream cone there is a
discount, and Bob has to pay only $ 1.
Derive Bob’s budget constraint and compute his optimal consumption plan. Hint:
write the budget constraint for each of the cases x1 ≤ 10 and x1 > 10.

2. (Similar to JR 1.53). Consider the Cobb Douglas utility function

u (x1 , x2 ) = xα1 x1−α

2 .

where α ∈ (0, 1). Use FOC to:

(a) Derive the Marshallian demand functions.

(b) Derive the indirect utility function.
(c) Compute the expenditure function.
(d) Compute the Hicksian demands.

To check that what you’ve computed above corresponds to the right optima: is this
utility function concave, or quasi-concave? Do the second order conditions hold?
3. John derives utility from wine (x1 ) and beer (x2 ) . His utility function is

u (x1 , x2 ) = x21 + x2 ,

and his income is $ 300. Draw John’s indifference curves.

Initially the price of wine and beer are p1 = 15 and p2 = 5, respectively. Then the price
of wine increases by $ 5, i.e., pnew
1 = 20 (the price of beer does not change). Under
the new price, find the income which allows John to obtain the same level of utility he
could get before the price changed.