Econ 50: Modified Section 3

October 9, 2015

1 Clarification from Section and Class

1. Deadweight loss: over-production, under-production, inefficient buyers/sellers

(a) Practice problem from last section: Recall basic setup (small open economy,
world price below domestic equilibrium price; government imposes a tariff of 1
or equivalent quota).

(b) Q4 from problem set 2

A substantial part of these notes is based on notes from a previous TA. These notes are at best a
summary of the section. They are not intended to and will not serve as a substitute to attending the section.

1
 (c) Q5(C) from problem set 2

2. Individual and market demand/supply (again!!): Consider a market with two suppliers
Qs1 = P 1 and Qs2 = 2P 5. What is the market demand?


s P 1 1 P 2.5
Q =
3P 6 P 2.5

3. Convex preferences: mixtures are preferred to extremes.

2 Practice problem: Utility functions

For each of the following graphs, provide a utility function that represents these preferences:
a.

2
You were introduced to the concept of Utility Functions this week. Lets work through
the practice questions from your problem set to increase our comfort level with them.

1.1 Problem Set 2, Question 9

For each of the following, the suggested utility functions are only one of the many possible.

(a) For the following graph, u(x, y) = xy.

Chai Latte

Muffins

(b) For the following graph, u(x, y) = x y.

(b) For the following graph, u(x, y) = x y.
b.Brocolli
Brocolli

These notes are at best a summary of the section. They are not intended to and will not serve as a
substitute to attending the section.

Chocolate

Chocolate

(c) For the following graph, u(x, y) = x.

c. (c) For the following graph, u(x, y) = x.
Apple
Apple

Steaks
Steaks

d. (d) For the following graph, u(x, y) = min{x, 5y}.

(d) For the following graph, u(x, y) = min{x, 5y}.
Jeans
Jeans

3
PoloShirts
PoloShirts
 Steaks

(d) For the following graph, u(x, y) = min{x, 5y}.

Jeans

PoloShirts

(e) For the following graph, u(x, y) = (x 2)2 (y 4)2 .

e.
Milk

Brownies

Solutions:
1.2 Problem Set 2, Question 10
a. U (x, y) = xy
b. UYouve x ygiven six utility functions and you have to figure out which, if any, represent
(x, y) =been
c. U (x,
they) = xpreferences. There are two ways of doing this (a) show that they are monotonic
same
d. Utransformations
(x, y) = min(x, 5y)
of each other and (b) show that they have the same MRS. We shall use the
e. U (x, (x 2)2 (y 4)2
y) =method.
former
Note that,
1/3 2/3
uE (x, y) = 4 ln(x) + 8 ln(y) = 12 ln(x y )
3 Non-Linear Budget Line 6
uF (x, y) = x2 y 4 = x1/3 y 2/3
When dealing with budget constraints, what you have seen in class so far (and will see
and uA (x, y) = x1/3 y 2/3
more of in your future problem sets) are linear budget lines. i.e. There were no kinks in the
budget line. Is this always the case? No, definitely not. Intuitively, 6 what a linear budget
or simply,
line means uE (x,
is that they)prices
= 12 ln(u
faced
A (x,
by y))
theand u
consumer
F (x, y)
do= u
not (x,
change
A y) . That
with theisamount
to say, of
thethe
utility
goodsfunctions uA , But
purchased. uE and uF represent
we know sameworld
that in the real preferences
this isbecause
not the u E and
case. uF are
Often, wemonotonic
come
transformations of uA .
Also, 4

uB (x, y) = x2 + 4xy + 4y 2 = (x + 2y)2

and uD (x, y) = e3x+6y = e3(x+2y)
2 Non-Linear Budget Line

2.1 Quantity Discounts

When dealing with budget constraints, what you have seen in class so far (and will see
more of in your future problem sets) are linear budget lines. i.e. There were no kinks in the
budget line.1 Is this always the case? No, definitely not. Intuitively, what a linear budget
line means is that the prices faced by the consumer do not change with the amount of the
goods purchased. But we know that in the real world this is not the case. Often, we come
across quantity discounts i.e., the price drops if the consumer is willing to buy more than
a certain pre-specified amount.
across quantity The following
discounts, i.e. the example shows
price drops thisconsumer
if the quite clearly.
is willing to buy more than
Example 1: Discount on Additional Units. Assaf has an income of $600clearly.
a certain pre-specified amount. The following example shows this per month,
which he spendsExample
on Coca-Cola (x) and comic
1: Discount books (y).Units
on Additional Each Assaf
can ofhas
Coca-Cola
an income costs $1; per month,
of $600
each comic book
whichcosts $3. Assaf
he spends belongs to (x)
on Coca-Cola a frequent
and comic buyer
booksprogram thatcan
(y). Each allows him to costs $1;
of Coca-Cola
pay just $2 each
(instead
comicof book
$3) for all $3.
costs comic books
Assaf beyondtothe
belongs 50th bookbuyer
a frequent he buys each month.
program that allows him to
That is, the pay
firstjust
50 comic books will
$2 (instead cost
of $3) for$3alleach;
comicany beyond
books that will
beyond cost $2
the 50th bookeach.
he Write
buys each month.
down a mathematical
That is, the expression for Assaf
first 50 comic bookss will
budget
costconstraint and beyond
$3 each; any sketch his
thatbudget set.$2 each. Write
will cost
down a mathematical expression for Assafs budget constraint and sketch his budget set.
Lets do the easy bit first draw the budget set. Its clear from above that the price of
It is clear from above that the price of y drops beyond the 50th and theres no change
y drops beyond the 50th and theres no change in the price of x. In other words, once Assaf
in the price of x. In other words, once Assaf has bought 50 comic books, the budget line is
has bought 50 comic books, the budget line is going to get steeper because the price of y
going to get steeper because the price of y relative to x has decreased. So, there will be a
relative to x has decreased. So, therell be a kink in the budget line at y = 50.
kink in the budget line at y = 50.

y
Discount
275

No Discount

50

450 600 x

In the aboveInfigure I haveabove

the figure all the
allintercepts labeled.
the intercepts haveThese
been can be worked
labeled. These out
can once we out once
be worked
have the equation
we have of the
the equation
budget line. Sobudget
of the lets figure
line. that out figure
So lets now. Its pretty
that clear Its
out now. thatpretty
the clear that
1 the the
Theoretically, budget line
budget is could be a curve as well, but we shall not deal with such cases in this
line
course.
600 = x + 3y if 0 y 50. For y > 50,the budget line is 550 = x + 2y. Its calculated
as follows:
2
600 = x + 2(y 50) + (3)(50) = 600 = x + 2y 100 + 150 = 550 = x + 2y
Example 2: Discount on All Units Everything is the same as the previous example
except that the discount is now on all the units, i.e. if you buy 50 units, each of those
costs $3, which makes the total expense $150 but if you buy 51 units, each of those costs
$2 which makes the total expense $102. Here is what the budget set looks like:

5
 ) 600 = X + 2Y 100 + 150
) 550 = X + 2Y

Example 2: Discount on All Units. Everything is the same as the previous example
except that the discount is now on all the units i.e. if you buy 50 units, each of those
costs $3, which makes the total expense $150 but if you buy 51 units, each of those costs $2
which makes the total expense $102.

Here is what the budget set looks like:

y
Discount
300

No Discount

50

450 500 600 x

and the equation of the budget line is given by

and the equation of the budget line is given by:
(
x + 3y = 600 if 0 y x50+ 3y, if 0 y 50
600 =
x + 2y = 600 if y > 50 x + 2y, if 50 < y