Microeconomics

Academic Year 2018/19

Corso di Laurea in Economics and
Finance (CLEF)
Course Lecturer Matthew Wakefield

Microeconomics

Course Lecturer: Matthew Wakefield

Text book:

Hal R. Varian,
INTERMEDIATE MICROECONOMICS:
A Modern Approach
9th International Student Edition

1
 Microeconomics

Exercises

Mathematical Background

Exercises: Mathematical Background

1. Solve a simple one-variable equation

• 3x + 7 = 10, x=?
• x=1
• 24 + 7/a = 38, a=?
• a=½
• To try “at home”:
• 6y + 12 = 36, y=?
• 9 + 4/b = 12, b=?

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 Exercises: Mathematical Background

2. Manipulate multi-variable additive equations:

• V = 0.1 S + 2 t + 0.05 u
• If S = 10, t = 0.5 & u = 20, V=?
• 3
• If V = 5, t = 0.5 & u = 20, S=?
• 30
• To “try at home”:
• If S = 5, t = 2 & u = 12, V=?
• If V = 6, S = 20 & t = 1, u=?
3

Exercises: Mathematical Background

3. Manipulate certain other multi-variable equations:

• y = 0.3 (m/p)
• m = 10, p = 2, y=?
• 1.5
• y = 3, p = 5, m=?
• 50
• To “try at home”:
• m = 25, p = 2.5, y=?
• y = 3, m = 20, p=?
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 Exercises: Mathematical Background

4. Graphs: Draw and manipulate straight lines

• Suppose C, P, and MR, all measured in Euros, are given by:
C = 100
P = 200 – 4x
MR = 200 – 8x
Plot these lines on a single graph with “Euros” (i.e. number of
euros) on the vertical axis and x on the horizontal axis.
Be sure to label all curves / lines and the values at which these
lines intersect the axes
• Graphic on the board in class
• Try same exercise with: C = 200, P = 300 – x/2, MR = 300 - x
5

Exercises: Mathematical Background

5. Converting words into equations and lines:

• Suppose John will use exactly 10 euros to buy some
combination of magazines (price 2 euros each) and coffees
(price 1 euro each).
• What is the maximum number of magazines that John could
buy? The maximum number of coffees?
• Plot out the combinations of magazines and coffees that John
could buy, putting “m” (number of magazines) on the horizontal
axis, and “c” (number of coffees) on the vertical axis. [Note that
John canNOT buy negative amounts of “m” or “c”.]
• 5, 10, on board
• How would the answers change if:
• the price of a magazine were 2.50 euro?
• John will spend 20 and prices are 4 (magazines) and 2 (coffees)?
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3
 Exercises: Mathematical Background

6. Familiar with functions of the form:

V = A xc y d
and the special case where c + d = 1 so that:
V = A xb y(1-b) , ( 0 < b < 1 )
For particular values of V, A and b, this describes a smooth,
negatively sloped curve in (x,y) space.
In lecture we take A = 2, b = 0.25, and let V = 16. The curve then
passes through (1,16), (8,8) and (27, 5 1/3)
• Graph in lecture

Exercises: Mathematical Background

7. If we know
2 x 0.5 y -0.5 = 27
2 x -0.5 y 0.5 3
Then what is x = x(y)?
• x = 9y (method in class)

Try “at home” with:

4 x 0.5 y -0.5 = 24
4 x -0.5 y 0.5 4
What is y = y(x)

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 Exercises: Mathematical Background

8. Knowledge of differentiation not essential; may aid understanding

A derivative measures the “slope” or “gradient” of a line. [in lecture]
In a “power expression”, y = a xb , the derivative is given by:
dy/dx = ab x(b-1)
• Examples: y = 200, y = 2x, y = 3x3 , y = 3x1/3 , in lecture

We will often need the “partial derivative” (denoted with curly ∂y/∂x )
of a function with two dependent variables. This is the derivative
of y wrt x, when all else stays constant. To get it, simply
differentiate wrt x, treating other dependent variables as
constants (part of a in expression above). e.g.
• Partial derivative of v = 4 x 0.5 y 0.5 , in lecture
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Microeconomics

Questions / Exercises

Consumer Theory
Exercises Based on Chapters of Varian

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 Chapter 1

 The variables that are explained within an

economic model are:

a) Exogenous
b) Fixed
c) Interesting
d) Endogenous

The variable you want to understand better be ... ?

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Chapter 1

 Suppose that the ticketing system for the world

cup, has allocated tickets at £100 to some fans
who were just willing to pay that price (but no
more). Other fans who would have paid £200 did
not get tickets. This outcome:
a) Is not Pareto efficient
b) Is unambiguously undesirable
c) Is probably due to the fact that England might
beat Sweden (who eliminated Italy) on their way
to the semi-finals ...
d) Both a) and b)

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6
 Chapter 2

 The currency in the town of pricey pizza is “crowns”.

If a slice of pizza costs 4 crowns, and a beer costs 5 crowns,
what is the opportunity cost of a beer in terms of slices of
pizza?

a) 4/5
b) 1
c) 1.25
d) 9
e) None of the above

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Chapter 2 Food Stamps Exercise

Suppose that a family has a weekly income of m = $100. Suppose also that the
family buys food and other goods, and that the price of a unit of food is $1 and
the price of a unit of other goods is $1. Let F be the number of units of food
bought, and G the number of units of other goods.

(a) What is the equation of the family’s budget line?

(b) Draw the budget line with G on the vertical axis and F on the horizontal axis.
Now suppose that in addition to the $100 of cash, the family is given 40 food
stamps. Each stamp can be exchanged for $1 of food, but cannot be used to buy
other goods.
(c) How many units of other goods can the family afford if it buys:
(i) F=0; (ii) F=20; (iii) F=40; (iv) F=60; (v) F=100; (vi) F=140?
(d) On your graph from part (b), add the new budget line with the food stamps
added to the budget.
Finally, suppose that there is a black market so that each food stamp can be
sold for a price of $0.5 (i.e. 50 cents)
(e) How many units of other goods can the family afford if it buys:
(i) F=0; (ii) F=20; (iii) F=40; (iv) F=60; (v) F=100; (vi) F=140?
(f) On your graph from parts (b) and (d), add a new budget line that shows how
food stamps and the black market affect the budget.
(g) With the black market, how many extra units of other goods can the family
buy if it gives up one unit of food when: (i) F≤40; (ii) F≥41 ?
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 Chapter 2 Food Stamps Exercise
Sketch solutions

(a) F + G = 100
(b) [Graphic]
(c) (i) 100 (ii) 100 (iii) 100 (iv) 80 (v) 40 (vi) 0
(d) [Graphic]
(e) (i) 120 (ii) 110 (iii) 100 (iv) 80 (v) 40 (vi) 0
(f) [Graphic]
(g) (i) 0.5 (ii) 1

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The Food Stamp Program

G
F + G = 100: before stamps.

100 Budget set after 40 food

stamps issued.

The family’s budget

set is enlarged.

40 100 140 F

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 The Food Stamp Program
G
F + G = 100: before stamps.
120
Budget constraint after 40
100
food stamps issued, w black market
Black market trading makes
the budget set larger again.

F
40 100 140
• Only sell some stamps if do not want $40 or more of food
• If food stamps are sold, slope of the constraint is -0.5
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Chapter 2 Exercise

Suppose that a pensioner has a budget of 100 euro per week.

Suppose that we are interested in analysing her consumption of
domestic fuel, and that she can buy fuel at 5 euro per unit. Any euros
she does not spend on fuel will be spent on other goods.

Draw the pensioner’s budget constraint between fuel and other goods,
with quantity of fuel on the horizontal axis and quantity of other goods
(measured in euros spent) on the vertical axis. Be careful to label the
axes and the values at which the budget line intersects (crosses) the
axes.

Now suppose that the Government offers a 1 euro subsidy on each of

the first ten units of fuel that a household buys each week.
How does this change the budget constraint?
Draw the modified budget constraint on your graph. Be careful
to label the values of any new intercepts with the axes.

[Intercepts: vertical 100 euro, horizontal, 20 then 22. Graphs on board]

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 Chapter 3

 Suppose that Ernie’s preferences over films are such that he

likes action movies better than romantic comedies; prefers
romantic comedies to period dramas, and chooses period
dramas rather than action movies.
a) Ernie’s preferences are not complete
b) Ernie’s preferences are not transitive
c) Ernie’s preferences are not reflexive
d) Ernie should become a film critic
e) None of the above

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Chapter 3

 A consumer is drinking fourteen coffees and seven cups of

tea per week. He would be indifferent between this bundle
and thirteen coffees and nine cups of tea. How much is the
individual “willing to pay” for his 14th coffee?

a) Half a cup of tea

b) One cup of tea
c) Two cups of tea
d) None of the above

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 Chapter 3

 Hermione Fruitnut says: “I love fruit; give me an apple or

give me two oranges, I don’t care which, I get lots of
pleasure from eating an apple but I get just as much
pleasure from eating two oranges”.
For Hermione, an apple and two oranges:

a) Are perfect complements

b) Are perfect substitutes
c) Must have the same price
d) None of the above

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Chapter 4

 Suppose that John’s preferences are described by

a utility function such that bundle x has utility
value 12, bundle y has value 24 and bundle z has
value 18. We can say that it is a general truth
that:
a) John likes y twice as much as x
b) John likes z six units more than x
c) John’s preference for z is exactly half way
between his preference for x and y
d) John prefers y to z to x
e) Both c) and d)
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 Chapters 3 & 4
 Charlie consumes Apples and Bananas. Let Xa be the quantity of apples that
he consumes and xb be the quantity of bananas that he consumes. Suppose
that Charlies utility function is:

u(Xa,Xb) = XaXb

a) Charlie has 40 apples and 5 bananas; his utility for this bundle
is __________ ?

b) The indifference curve through (40,5) contains all bundles such that
XaXb = ________ . So the indifference curve through (40,5) has the equation
Xb = ________ .

c) Draw the indifference curve through (40,5), on a graph with Xb on the vertical
axis and Xa on the horizontal axis.

d) Donna offers to give Charlie 15 bananas if he will give her 25 apples in

return. Will the trade leave Charlie with a bundle that he likes better or worse
than (40,5)? What is the most apples Charlie will give to Donna while
remaining willing to, or at least indifferent about, trading?

[a) & b(i)) in lecture; b(ii)) 200/Xa; c) in lecture; d) Yes and 30.]
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Chapter 4
 We saw an estimated utility function for the commute to work, of
the form:
U = - 0.147 TW – 0.0411 TJ – 2.24 C
Where TW is time walking (mins), TJ total journey time (mins), and C
the cash cost of the journey by a given means of Transport (car or
public transport).
i. According to this utility function, what is the marginal utility of a
minute saved of total journey time?
ii. Approximately how many minutes of extra total journey time
would the consumer sacrifice to save a minute of walking?
iii. How much would the consumer pay to save this minute of walking?
iv. If the utility function were doubled, which of your answers to i., ii.,
and iii., would change?
v. According to this utility function, is the marginal (dis)utility of each
characteristic increasing, constant or diminishing? Do you think
this assumption is reasonable?

[i. 0.0411; ii. 3.6; iii. Approx 7 cents; iv. MUs change, MRSs do not,
discussion in lecture; v. Constant. Discussion in the lecture.] 24

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 Chapter 5

 A consumer is buying two goods, a and b. If his

preferences are well behaved and strictly convex,
if he makes an optimal choice that is an interior
solution, then
a) He will exhaust his budget
b) He will consume a positive amount of both goods
c) He will set his marginal rate of substitution for
these two goods equal to minus the ratio of their
prices
d) All of the above

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Chapter 5

 If two individuals both face the same market

prices for tea and coffee, and both buy some tea
and some coffee, then if they choose optimal
demands for tea and coffee they will have the
same:
a) Marginal utility of tea
b) Marginal utility of coffee
c) Marginal rate of substitution between tea and
coffee
d) Preferences
e) a) and b) and c) are correct
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 Chapter 6

 If good A is a normal good for Dan, and when its

price goes up Dan buys more of good B, then for
Dan:
a) A and B are gross substitutes
b) A and B are gross complements
c) A and B are perfect substitutes
d) We do not have sufficient information to say

[Other definitions in chapter 6: normal/inferior; ordinary/Giffen; ...]

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Utility and demands (chs 4 & 6)

 Rob’s utility function between consumption of food (f) and
consumption of other things (c), is accurately described by:

u(f,c) = f0.4c1.6

(So marginal utilities are ∂u/∂f = 0.4f-0.6c1.6

and ∂u/∂c = 1.6 f0.4c0.6
And his budget is a fixed money income m.
1. Can we say what proportion of income Rob will spend on food?
Other goods?
2. With this chosen utility function, how does the proportion of
income spent on either good, vary with income or with prices? In
the light of this, what observations would lead you to suggest the
suggested functional form as apropriate for modelling preferences?
3. Derive demand curves for food and other goods. Suppose that the
price of food is 2 and the price of other goods is (normalised to) 1.
How much of each is demanded if income is 150? 200?
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 Utility and demands (chs 4 & 6)
 Rob’s utility function between consumption of food (f) and
consumption of other things (c), is accurately described by:

u(f,c) = f0.4c1.6

(So marginal utilities are ∂u/∂f = 0.4f-0.6c1.6

and ∂u/∂c = 1.6 f0.4c0.6
And his budget is a fixed money income m.
1. 0.2, 0.8
2. Don’t vary
3. In class

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Chapter 2 (& 8)

Delia Jones is in the habit of drinking glasses of wine while

watching TV cookery programs that are provided on a “pay
per view” basis. She drinks 2 glasses of wine during each
cookery program, will not watch cookery programs if she
does not have two glasses of wine available, and only drinks
wine while watching cookery on TV.
On a graph, draw 3 of Delia’s indifference curves for the
choice over glasses of wine, and cookery programs. Draw
the indifference curves that go through the points (2
glasses of wine,1 program), (6 glasses, 3 programs) and
(10 glasses, 5 programs). Put the number of glasses on the
horizontal axis, and the number of programs on the vertical
axis.
[In class]
If the price of wine falls (due to a bumper harvest in France,
What will be the change in Delia’s demand for wine due to
the substitution effect? [In class]
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 Chapters 6 and 8

 If Suzy consumes two goods, one of which is a

Giffen good, and she always (for any level of
income) spends all of her money, then the other
good:
a) Must be a normal good
b) Must be an inferior good
c) Could be an inferior good
d) Must not be an ordinary good

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Chapter 8

 The following can be said about the change in demand due

to the income and substitution effects for a good whose
price rose:
a) The change due to the income effect is always positive and
the change due to the substitution effect is always negative.
b) Both can be either positive or negative.
c) While change due to the substitution effect is always
negative, the change due to the income effect can be either
positive or negative.
d) While the change due to the income effect is always
negative, the change due to the substitution effect can be
either positive or negative.
e) The change due to the income effect can at times be
positive, but it will never overwhelm the change due to the
substitution effect.
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 Chapter 9

 Marsha Mellow is very flexible. She consumes x and y. She says,

“Give me x or give me y, I don’t care. I can’t tell the difference
between them.” She is currently endowed with 14 units of x and 3
units of y. The price of x is 3 times the price of y. Marsha can trade x
and y at the going prices but has no other source of income. How
many units of y will Marsha consume?
a) 48
b) 17
c) 45
d) 3
e) 23

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Income and Substitution Effects (ch8)

• Harry likes occasionally to drink a bottle of Belgian beer. In particular, his
monthly demand for bottles of beer is:
Xb = 0.01M – 0.2Pb
• Where Xb is the number of beers drunk per month, M is Harry’s monthly
budget to spend on food and drink, and Pb is the price of a bottle of beer.
(Note that Xb is an average demand and need not be a whole number).
a) Suppose that Harry’s budget M = 500 euro, and the price is Pb = 5 euro. How
many beers, on average, will Harry drink per month?
b) Suppose the price falls to Pb = 4. How many beers will Harry buy now? What
is the total change in demand due to this price change?
c) Given the new price (Pb = 4), how much would Harry’s income need to be
reduced to leave him just able to afford the number of beers calculated in part
(a), without him needing to alter his demand for other goods? (In other words,
how much would Harry’s expenditure on beers have gone down if (all else
unchanged) he had continued to buy the number of beers calculated in (a)?)
d) Compute the change in Harry’s demand for beers that is due to the
substitution effect.
e) What is the change in Harry’s demand for beers due to the income effect? Are
beers a normal or an inferior good for Harry? 34

17
 Income and Substitution Effects (ch8)
• Harry likes occasionally to drink a bottle of Belgian beer. In particular, his
monthly demand for bottles of beer is:
Xb = 0.01M – 0.2Pb
• Where Xb is the number of beers drunk per month, M is Harry’s monthly
budget to spend on food and drink, and Pb is the price of a bottle of beer.

a) 4
b) 4.2 & 0.2
c) - 4 euro
d) 0.16 bottles
e) 0.04. Normal good (check demand function)

35

Labour Supply question (ch 9)

 Suppose that an individual has available 70 hours a week which he
can allocate between work (l) or leisure (R). Suppose that she
receives a wage rate of 4 euros and hour, and that the other good
that provides her with utility is consumption spending (C),
measured in euros.
i. Draw the budget line for this consumer’s problem, putting R on the
horizontal axis and and being careful to label axes and the
intercepts of the curve..
ii. Now suppose that the employer introduces an overtime payment of
1.5 times the normal wage rate (i.e. Of 6 euros per hour) for hours
in excess of 40 hours. How does this modify the budget constraint?
Add this to your diagram.
iii. Suppose an individual was rationally choosing 40 hours or work
before the overtime pay was introduced. Will she supply more or
fewer hours? (Explain in terms of income and substitition effects.
You may use a diagram if you choose.
iv. Repeat part iii., for an individual who was originally supply 45
hours. 36

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 Labour Supply question (ch 9)
 Suppose that an individual has available 70 hours a week which he
can allocate between work (l) or leisure (R). Suppose that she
receives a wage rate of 4 euros and hour, and that the other good
that provides her with utility is consumption spending (C),
measured in euros.
i. In class
ii. In class
iii. Increase
iv. Ambiguous.

Think about EITC example.

37

Chapter 15

 Suppose that Andrew and Brenda are the only consumers in

the market for widgets and that their respective demands
are given by:
Wa = 24 – 3P and Wb = 16 – P
where Wa is the quantity of widgets demanded by Andrew, Wb
the quantity demanded by Brenda, both Wa and Wb have
minimum values of 0, and P is the price of a widget.
If price is 9, what will be market demand?
a) 0
b) 4
c) 7
d) None of the above

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 Chapter 15

 If a good has an income elasticity of demand that is positive

but smaller than 1, this good is:

a) A normal good
b) A necessity
c) A luxury
d) Both (a) and (b) are correct

39

Chapter 16

Suppose that widgets are available with a fixed level of supply,

and demand for them is described by a downward sloping
demand curve. If the government imposes a quantity tax on
widgets this will:
a) Result in no change in the price paid by consumers to buy
widgets
b) Result in no deadweight loss
c) Be entirely borne by the suppliers of widgets
d) All of the above

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 Chapter 16
Suppose that market demand and supply for “thingies” are described
by the inverse demand function: P = 1600 – 8Q, and the inverse
supply function: P = 100 + 2Q (where P is the price in euros, and Q is
the number of thingies).

(a) What are the ordinary demand and supply functions?

(b) What are equilibrium price and quantity for thingies?

Now suppose that thingies are subject to a sales tax (levied on the
buyer) of 40 euro per thingy.

(c) With the tax, what are: (i) the equilibrium price that sellers receive
for each thingy; (ii) the equilibrium (tax inclusive) price paid by buyers
for each thingy bought; (iii) the quantity of thingies that gets traded?
(d) Repeat the analysis of point (c), but now for an excise tax (levied
on the seller) of the same value.
(e) Draw a single graph that shows the initial supply and demand for
thingies, and the initial market equilibrium; and, the market
equilibrium after the quantity tax is introduced (you need show this
only for one of the two taxes (the sales tax or the excise tax) – there is
no need to draw both cases). 41

Chapter 16
Suppose that market demand and supply for “thingies” are described
by the inverse demand function: P = 1600 – 8Q, and the inverse
supply function: P = 100 + 2Q (where P is the price in euros, and Q is
the number of thingies).

(a) Q = 200 – (1/8)P and Q = (1/2)P – 50

(b) P = 400; Q = 150

Now suppose that thingies are subject to a sales tax (levied on the
buyer) of 40 euro per thingy.

(c) (i) ps = 392; (ii) pb = 432; and, (iii) Q = 146

(d) Answers as in part (c)
(e) In lecture.

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 Microeconomics

Questions / Exercises

Consumer Theory
Exercises Based on Chapters of Varian

22