Answer Keys (Problem Set-1)

1. (a)

(b)
(c)

(d)

2.
(a)
(b)

(c)

3.
Individual A has relatively flat indifference curves, since A requires relatively large numbers
of coconuts to compensate for the loss of pineapples that she values highly.

Individual B has relatively steep indifference curves, since B requires relatively few coconuts
to compensate for the loss of pineapples that he does not value highly.

C's indifference curves are vertical; the level of satisfaction is affected only by coconuts.

D's indifference curves are horizontal; the level of satisfaction is affected only by pineapples.

E's indifference curves are L-shaped.

MRS measures (at the margin) the maximum number of pineapples that the consumer will be
willing to give up in order to get one more unit of coconuts.

A's MRS is low. A is willing to relinquish few pineapples relative to coconuts since
pineapples are dear to A.

B's MRS is high, for the opposite reason.

C's MRS is infinite. Since C's utility is not affected by pineapples, she is willing to relinquish
all pineapples (an infinite number) to obtain additional coconuts.

D's MRS is zero. D is not willing to give up any pineapples to obtain additional coconuts.

E's MRS is infinite when Qp > Qc, zero when Qc > Qp, and undefined when Qc = Qp.

4. These preferences do not exhibit a diminishing marginal rate of substitution since

consumers are always willing to substitute the same amount of store-brand sugar for an
additional pound of producer-brand sugar.

5. The two graphs are shown below. It can be seen from both graphs that this function does
not satisfy the law of diminishing marginal utility. The first figure shows that utility increases
with x, and moreover, that it increases at an increasing rate. For example, an increase in x
from 2 to 3, increases utility from 12 to 27 (an increase of 15), while an increase in x from 3
to 4 induces an increase in utility from 27 to 48 (an increase of 21).
This fact is easier to see in the second figure. The marginal utility is an increasing function of
x. Higher values of x imply a greater marginal utility. Therefore this function exhibits
increasing marginal utility.

U(x) = 3x2
 MUx = 6x

7. (a)
F
Preference
Directions

A
B
C
H
(b) At point A, Dr. Strangetaste’s indifference curve, which is bowed out from the origin,
is tangent to his budget line. This point is not an optimum because, for example, Dr.
Strangetaste could move to point B on his budget line and achieve a higher level of total
utility. Point B, though, is not an optimum either because Dr. Strangetaste could move to
point C, a corner point, to achieve an even higher level of total utility. When the MRS is
increasing, a corner point optimum will occur (with F = 0 in this picture, though it could
equivalently be with H = 0 for another set of indifference curves).

8. When the consumer maximizes utility, his optimal consumption basket will be on the
budget constraint and satisfy the tangency condition.
Any basket on the budget line will satisfy pxx + pyy = I, or 2x + 5py = 40.
The tangency condition requires that MUx / px = MUy / py, or that 5 / 2 = x / py. This implies
that 5py = 2x.
Putting these two equations together reveals that 5py + 5py = 40; thus py = 4.

9. This question cannot be solved using the usual tangency condition. However, you can see
from the graph below that the optimum basket will necessarily lie on the “elbow” of some
indifference curve, such as (5, 3), (10, 6) etc. If the consumer were at some other point, he
could always move to such a point, keeping utility constant and decreasing his expenditure.
The equation of all these “elbow” points is 3x = 5y, or y = 0.6x. Therefore the optimum point
must be such that 3x = 5y.

The usual budget constraint must hold of course. That is, 5 x+10 y=220 . Combining these
two conditions, we get (x, y) = (20, 12).

x
(20,12)

(10,6)
(5,3)
y

10. A half-price sale cuts the price of each and every unit in half. In contrast, a buy-one,
get-one-free deal does not change the relative price of any units between 0 and 1 unit.
Furthermore, it makes the price of units purchased between 1 and 2 units purchased
zero.