Problem Set 1 (Due Week 5)

Microeconomics: An Intuitive Approach

Chapter 2

TRUE/FALSE

1. If all consumers are price-takers facing the same prices, then their budget lines will all have the same
slope.

2. If all consumers are price-takers facing the same prices, then all choice sets are the same.

3. Regardless of which consumption bundle in her choice set a consumer chooses, she will spend all of
her available income.

4. Kinks in budget constraints always produce non-convexities in choice sets.

5. The only way for a consumer choice set to be non-convex is for the budget line to be kinked.

6. When the good on the vertical axis is a composite good, the slope of the budget line is equal to minus
the price of the good on the horizontal axis.

7. When the good on the horizontal axis is a composite good, the slope of the budget constraint is minus
the price of the good on the vertical axis.

8. While the endowment bundle must lie on the original budget line, it need not lie on the budget line
when prices change.

9. For choice sets emerging from “exogenous” income, the budget line will shift parallel whenever both
prices change by the same percentage.

10. For choice sets generated from endowment bundles, the budget line will shift parallel if both prices
change by the same proportion.

MULTIPLE CHOICE

1. The following changes in a consumer’s economic circumstances result in a steeper budget line with the
vertical intercept unchanged. (Denote the good on the horizontal as good 1 and the good on the vertical
as good 2.)
a. A k percent decrease in the price of good 2 combined with a k percent decrease in income
b. A k percent increase in the price of good 2 combined with a k percent decrease in income
c. A k percent decrease in the price of good 2 combined with a k percent increase in income
d. A k percent increase in the price of good 2 combined with a k percent increase in income.
e. None of the above

2. Suppose inflation comes in the form of an across-the board increase in all prices by some percentage k.
For a consumer with exogenous income operating in a 2-good world, this will cause the budget
constraint to
a. rotate inward d. shift inward in a parallel way
b. rotate outward e. none of the above
c. shift out in a parallel way
 3. Suppose you are given a coupon for pizza. This coupon lowers the price for each additional pizza you
buy by 5% for each addition pizza you buy. What happens to your budget constraint, with pizza on the
horizontal axis and a composite good on the vertical?
a. The vertical intercept remains the same but the slope becomes steeper as more pizzas are
bought.
b. The vertical intercept increases and the slope becomes steeper as more pizzas are bought.
c. The vertical intercept remains the same but the slope becomes shallower as more pizzas
are bought.
d. The vertical intercept increases but the slope becomes shallower as more pizzas are
bought.
e. None of the above.

4. Suppose the government wants to discourage excessive consumption of alcohol. It therefore imposes a
per-unit tax on alcohol that increases as more alcohol is bought by a consumer at a store. What
happens to a consumer’s budget at a liquor store (with liters of alcohol on the horizontal axis and a
composite good on the vertical) --- assuming the consumer takes only one trip to the store.
a. The vertical intercept decreases and the slope becomes shallower as more alcohol is
bought.
b. The vertical intercept remains constant but the slope becomes shallower as more alcohol is
bought.
c. The vertical intercept decreases and the slope becomes steeper as more alcohol is bought.
d. The vertical intercept remains constant but the slope becomes steeper as more alcohol is
bought.
e. None of the above.

SHORT ANSWER

1. Consider a consumer with a choice set that emerges from an exogenous income I. Suppose that, as a
result of changes in a consumer’s economic circumstances, the budget line rotates outward, with the
vertical intercept remaining unchanged but the horizontal intercept shifting to the right. How could this
have happened if the price of the good on the horizontal axis did not change?
 2. Suppose that the price of a TV is $200 and he price of an MP3 player is $50. What is the opportunity
cost of a TV (in terms of MP3 players), and what is the opportunity cost of an MP3 player (in terms of
TVs)?

3. A consumer has $1,000 a week to spend on renting square feet of housing (at a price of $5 per square
foot) and eating out (at a price of $20 per meal). With square feet of housing on the horizontal and
meals on the vertical axis, what is the vertical intercept and what is the slope of this consumer’s budget
constraint?

PROBLEM

1. Suppose the government levies a per-unit tax on TVs, and this tax increases the price of TVs by $10.

a. On a graph with TVs on the horizontal axis and “$’s of other consumption” on the vertical, illustrate
how the budget constraint for a consumer with exogenous income changes as a result of the tax.
 b. Suppose you know the bundle on the after-tax budget that is chosen by the consumer. Illustrate on
your graph how much in tax revenue the government is raising from this consumer.

c. If the government replaced the tax on TVs with a lump sum tax that does not alter any prices but
raises the same amount of revenue from the consumer, how would this consumer’s budget constraint
change?

2. Suppose a business offers a 10% discount on the good x1 that it sells.

a. Illustrate a consumer’s before and after-discount budget constraint by modeling x2 as a composite

good.
 b. Suppose you observe only the after-discount consumption decision of the consumer. Can you tell
from this information how much revenue the firm is giving up (from this consumer) by offering the
discount? If so, illustrate this in your graph.

c. Suppose that, instead of the firm offering the 10% discount, the government subsidized consumption
of x1 sufficiently to reduce p1 by 10%. Suppose again that you only observe the after-subsidy decision
of the consumer. Can you tell how much of a subsidy payment is made to this consumer by the
government? If so, illustrate it in your graph.

d. Why are your answers to (b) and (c) different?

Microeconomics: An Intuitive Approach

Chapter 4

TRUE/FALSE

1. Complete tastes are tastes that make people desire at least some of every good.
 2. If you observe me choosing bundle A over bundle B on Monday, bundle B over bundle C on Tuesday
and bundle C over bundle A on Wednesday, it must be that my tastes violate transitivity.

3. You like bundle A better than bundle B, and bundle C is an average between A and B. If your tastes
satisfy convexity, then C is at least as good as A and as B.

4. Bundle A is worse than bundle B, and bundle C is an average of bundles A and B. Then our usual
assumptions about tastes imply that bundle B is at least as good as bundle C.

5. The number of units of the good on the horizontal axis that we are willing to give up to get one more
unit of the good on the vertical axis is equal to the absolute value of the slope of the indifference curve.

6. If the marginal rate of substitution is not diminishing, it must mean that tastes violate convexity
(assuming that our other assumptions about tastes hold).

7. Suppose tastes are NOT monotonic anywhere. Then diminishing MRS is not consistent with convexity
of tastes.

8. When the price of beer goes up, our model of tastes would typically require tastes to change.

MULTIPLE CHOICE

1. You like bundle A better than bundle B, and bundle C is an average of bundles A and B. Which of the
following is correct if your tastes satisfy our usual assumptions?
a. Bundle C is at least as good as bundle B.
b. Bundle A is at least as good as bundle C.
c. Both (a) and (b).
d. None of the above.
e. There is not enough information to tell.

2. Consider a worker who dislikes working end enjoys consuming a composite good. With labor hours on
the horizontal and the composite consumption good on the vertical axis, which of the following
statements are true.
a. If the worker’s tastes are convex, the slope of indifference curves increases as we move to
the right in the graph.
b. The worker becomes better off as we move to the northwest in the graph.
c. A tax on wage income does not change this worker’s indifference map.
d. All of the above.
e. None of the above.

SHORT ANSWER

1. Explain the following statement: For the same individual, tastes over goods may vary at the margin as
we move from one bundle to another.
 2. Explain the following statement: Individuals with different tastes might have the same tastes at the
margin at their current consumption bundles.

Microeconomics: An Intuitive Approach

Chapter 5

TRUE/FALSE

1. Homothetic tastes are always tastes over essential goods.

2. Tastes for perfect substitutes are both homothetic and quasilinear.

3. Tastes for perfect complements are both homothetic and quasilinear.

MULTIPLE CHOICE

1. Suppose consumer cannot taste the difference between Miller Lite and Bud Light, but Miller Lite is
sold in 12 ounce cans while Bud Light is sold in 8 ounce cans. In a graph with cans of Miller Lite on
the horizontal and cans of Bud Light on the vertical axis, which of the following is the correct slope
for this consumer’s indifference curves:
a. c.
b. -1 d. There is not enough information to tell.

SHORT ANSWER

1. Suppose our tastes are homothetic. It is often observed that people become more rigid --- more set in
their ways --- as they get older. Can you translate this observation into “economics-speak” by
discussing which feature of our tastes is likely the be changing as we get older?
 2. Suppose our tastes can be represented by the function . It is often
observed that people become more rigid --- more set in their ways --- as they get older. What
parameter is changing as we get older --- and how is it changing? (Explain.)

PROBLEM

1. Suppose the only characteristic of beer that a consumer cares about is alcohol content. Currently, Bud
Light and Miller Lite both have the same alcohol content.

a. Illustrate the consumer’s indifference curves in a graph with ounces of Miller Lite on the horizontal
and ounces of Bud Light on the vertical axis.

b. Suppose that the producers of Bud Light lower the price of Bud Light. How will your answer to (a)
change?

c. Suppose that the producers of Bud Light lower the alcohol content of their beer by 50%. How will
your answer to (a) change?
 d. Since we identify tastes with indifference maps, would you say that the consumer’s tastes have
changed in (b) or (c)?

e. How could we change the units we use to measure Miller Lite in order to get the indifference map in
(c) to again look like the one in (a)?

2. Suppose you are very picky about your outdoor BBQ experiences --- and you need exactly 1 cup of
lighter fluid for each bag of charcoal you use. If you have either leftover charcoal or leftover lighter
fluid, you simply discard it.
a. With cups of lighter fluid on the horizontal and bags of charcoal on the vertical axis, illustrate some
of your indifference curves.

b. Suppose that your favorite charcoal has just gotten better because the producer has infused the
charcoal with half a cup of lighter fluid per bag. How does your answer to (a) change?
 c. How could you change the units in which lighter fluid is measured on the horizontal axis to get your
graph from (b) to look the same as you original graph in (a)?

Microeconomics: An Intuitive Approach

Chapter 6

TRUE/FALSE

1. When the price of peaches went up, people bought fewer peaches and more strawberries. This is an
indication that tastes have changed as a result of the price increase.

2. The only way a consumer can optimize at a corner of her budget is if at least one of the goods is not
essential.

3. If not all goods are essential, a consumer will end up optimizing at a corner solution.

4. If all goods are essential, a consumer will optimize at an interior solution.

5. Suppose tastes satisfy our usual assumptions. Kinks in budget constraints do not give rise to the
possibility of multiple solutions unless the kinds produce a non-convexity in the choice set.

6. Ellie and Jenny both brought grapes and crackers in their school lunches. If they have different
marginal rates of substitution of grapes for crackers, their parents have not allocated lunch resources
efficiently.

7. If we were the only two people in the world and I like bananas while you hate them, efficiency
demands that I get all bananas.

8. You have observed a consumer who purchases only goods and and have concluded that the
consumer’s tastes are quasilinear in . Whether the consumer purchases more or less of when the
price of falls then depends on the size of the substitution effect.
MULTIPLE RESPONSE

1. Which of the following is correct about a consumer’s optimization problem:

a. In order for a consumer to not be optimizing at a corner solution, it is necessary for us to
assume that all goods are essential.
b. In order for a consumer to not be optimizing at a corner solution, it is sufficient for us to
assume that all goods are essential.
c. In order for a consumer to not be optimizing at a corner solution, it is necessary and
sufficient for us to assume that all goods are essential.
d. None of the above.

SHORT ANSWER

1. Which of the following statements is correct and which is not? Explain why.

a. When we all face the same prices, our tastes become the same.

b. When we all face the same prices, our tastes become the same at the margin.

2. Suppose that choice sets are convex. State assumptions about tastes that are necessary and sufficient to
guarantee that the solution to the consumer optimization problem is a unique interior solution.
(Explain)

3. Explain how we can estimate the shape of a person’s indifference map by observing choices under
different economic circumstances. Explain also why we will not be able to identify any non-
convexities in tastes from our observations.
PROBLEM

1. Currently, the price of consuming housing is lowered by the fact that home mortgage interest is tax
deductible. Suppose the government proposed to eliminate this implicit subsidy of your housing
consumption and at the same time lowers taxes on all other goods.

a. With housing consumption on the horizontal axis and all other consumption on the vertical, illustrate
you current optimal consumption bundle.

b. After looking over the government’s proposal, you decide that you don’t care one way or another
whether the government implements this proposal. On your graph, indicate your new budget constraint
and new optimal bundle under the proposal.

c. I also look over the proposal and find that my current consumption bundle also lies on the budget
constraint I would face under the proposal. Am I also indifferent between the two proposals?

2. In the movie “Baby Boom”, Dianne Keaton finds out that a relative tragically died in an accident and
bequeathed her an infant. The movie then explores how Dianne Keaton makes fundamentally different
choices as a result of this unexpected change in her life. It makes the point that new parents often
emphasize -- our “tastes change” when children enter the household.
a. Consider Dianne Keaton’s budget constraint over leisure (on the horizontal axis) and
consumption (on the vertical). What is the slope of the budget constraint? Indicate her optimal
choice A prior to finding out she suddenly has an infant child.

b. Suppose that the child came with a trust fund that permits Dianne Keaton to charge any child-
related expenses to that fund. Thus, the child does not come with any additional expenses –
and the budget constraint you derived in part (a) does not change. Still, we observe that Dianne
Keaton now chooses more leisure and less consumption. What must have happened to the
marginal rate of substitution at the bundle A in order for us to make sense of Dianne Keaton’s
change in behavior?

c. Draw the indifference curve through A before and after Dianne Keaton finds out she suddenly
has a child. If you ordinarily saw two such indifference curves (outside the context of this
example), could you think that these could emerge from the same map of indifference curves
or would you think they represent indifference curves from two different people whose tastes
differ? Explain.
d. Economists tend to resist the temptation of explaining changes in behavior as resulting from
changes in tastes. Rather, we tend to think of changes in behavior as arising from changes in
circumstances. Suppose that Dianne Keaton’s tastes are actually over three “goods” –
consumption of goods and leisure -- and “consumption” of children. Dianne Keaton’s true
indifference curves would thus be three dimensional – with your graphs so far representing
two dimensional “slices”. When viewed in this light, could the 2-dimensional indifference
curves you graphed in (c) arise from a single set of 3-dimensional indifference surfaces?
Explain (without attempting to graph anything in 3 dimensions).

e. Suppose that it had always been an option for Dianne Keaton to adopt a child, and suppose
that the cost of doing so is negligible. If Dianne Keaton reports being happier after she inherits
her relative’s child, was she fully optimizing before (assuming that she attaches no particular
value to the fact that the child she inherited was her relative’s)?

f. In principle, could Dianne Keaton’s tastes be such that she works more when she gets the child
and is still happier than before? Under the usual assumption about tastes – and treating
children the way we treat goods – could Dianne Keaton be less happy as a result of getting the
child?