Microeconomics—Answers for Assignment 1

Question 1

a. k = 2 x + 3 y
3 y = k − 2x
k 2x
y= −
3 3
b. k = ln( x) + b ln( y ), x  0, y  0
b ln( y ) = k − ln( x)
k ln( x)
ln( y ) = −
b b
k ln( x )
-
y = eb b

k 1
−
y = eb x b

c. k = ax 2 + by 2 , x  0, y  0, a  0, b  0
k 2 = ax 2 + by 2
by 2 = k 2 − ax 2
k 2 ax 2
y2 = −
b b
As y  0
k 2 ax 2
y= −
b b

Question 2
a. u ( x, y ) = ln( x) + y, 12=0.5x+y
u u 1
MRS = / =
x y x
p1 0.5 1
= =
p2 1 2
Set MRS = p1/ p2, we get x = 2
Plug x = 2 into 12 = 0.5 x + y, then get y = 11
x = 2, y = 11
b. u ( x, y ) = 2 x + y, 56 = 4 x + 7 y
u u
MRS = / =2
x y
p1 4
=
p2 7
As MRS is always larger than p1/p2, we will spend all of the budget on x, so
x = 14, y = 0

c. u ( x, y ) = e 2 x + y , 56 = 4 x + 7 y
u u
MRS = / =2
x y
p1 4
=
p2 7
As MRS is always larger than p1/ p2, we will spend all of the budget on x, so
x = 14, y = 0
*Take as given that the following 2 problems have an interior optimum.*
d. u ( x, y ) = ln ( x ) + y , 4 = 4x + y
u u 1 1
MRS = / = /
x y x 2 y
p1
=4
p2
Set MRS = p1/ p2, we get
2 y
=4
x
y
x=
2
plug it into 4=4x+y, we get
x+2 y − 4 = 0
y = 5 −1
y = 6−2 5
y
Plug it into x = , we get
2
5 −1
x=
2
5 −1
x= , y = 6−2 5
2
 e. u ( x, y ) = x − 3 + y, 25=0.25x+y
u u 1
MRS = / =
x y 2 x − 3
p1
= 0.25
p2
Set MRS = p1/ p2, we get
1
= 0.25
2 x −3
x−3 = 2
x=7
Plug it into 25 = 0.25 x + y, we get
1
y = 23
4
1
x = 7, y = 23
4

Question 3

a. Recall that for any tow bundles Z and Z’the following equivalence holds:
Z Z   u(Z )  u ( Z  )
Caculate the utility function from each bundle.
u ( A) = u (1, 4) = ln1 + 2 ln 4 = 0 + 2*1.4 = 2.8
u ( B) = u (4,1) = ln 4 + 2 ln1 = 1.4 + 2*0 = 1.4
Thus, since u ( A)  u ( B) the consumer prefers bundle A to bundle
B.

b. Convex preferences imply that for any three bundles X , Y , and

Z , if Y X and Z X then  Y + (1 −  ) Z X
From the example above take Y to be bundle A, and X to be
bundle B. Since preferences are reflexive B B, thus, we can
take Z to be bundle B. Thus, convexity of preferences implies
 A + (1 −  ) B B
Notice that C = 1/ 2 A + 1/ 2 B. Thus C B. To verify the
answer, calculate utility from C
u (C ) = u (2.5, 2.5) = ln(2.5) + 2 ln(2.5) = 2.7  1.4 = u ( B)
c. A bundle Z with consumptions given by ( xZ , yZ ) is indifferent to
the given bundle B when it yields the same utility as bundle B .
Utility that bundle Z yields
u ( Z ) = u ( xZ , yZ ) = ln xZ + 2 ln yZ
should be equal to u ( B) = 1.4. Thus, an equation for the indif-
ference through the bundle ( xB , yB ) = (4,1) is
ln xZ + 2 ln yZ = ln 4
ln xZ yZ2 = ln 4
xZ yZ2 = exp ln 4
4
yZ2 =
xZ
2
yZ =
x1/2
Z

MU x 1/ x y
d. MRS( x, y ) = − =− =−
MU y 2/ y 2x
2.5 1
MRS(2.5, 2.5) = − =−
2* 2.5 2
MRS is the rate at which two goods should be exchanges to keep
the overall utility constant. For example, at a point (2.5, 2.5), 1
unit of good x should be exchanged for 1/ 2 units of good y.

Question 4

a. Margarine and butter are perfect substituted for John. Since

margarine is sold in 8oz packages and butter is sold in 16oz
packages, one package of butter delivers twice as much utility as
one package of margarine.Thus, John s utility is given by
u(b, m)=m+2b
where m is the number of packages of margarine, and b is the
number of packages of butter. The following figure depicts indif-
ference curves in the (Margarine, Butter) plane
b. With the utility function specified above, the marginal rate of
substitution between margarine and butter is 2, while the price
p
ratio b = 3 / 2  2 . Since the market exchanges butter for mar-
pm
garine at a rate that is smaller than John is willing to exchange
the two goods, John will maximize his utility by spending all of
$6
his money on butter. He will buy = 4 packages of butter.
1.50
(Some more intuition: If John gives up one package of butter, he
will have $1.50 to spend on margarine, and will get 1.5 packages
of margarine. But to be as well of as before the exchange John
will have to receive 2 packages of margarine. Thus, such exchange
will make him worse off, and John will not give number of
packages of butter to exchange for margarine: He will consume
butter only.)
Question 5

a.(1) u1 ( x1 , x2 ) = 3 x12 x22

u1 u MU1 x
MU1 = = 6 x1 x22 MU 2 = 1 = 6 x12 x2 MRS = − =− 2
x1 x2 MU 2 x1
Preferences described by this utility function are mono-
tone since the utility function is increasing in both of
its arguments, x1 and x2 . An increase in the number of
each good in a bundle will increase utility, and therefore
a bundle with more of both goods will be preferred to a
bundle with less of each good.
An indifference curve is a set of points ( x1 , x2 ) that yield
the same level of utility u. Thus, an indifference curve is
described by the following equation
3 x12 x22 = u
Equivalently
1
C  u 2
x2 = where C =  
x1 3
To show that an indifference curve is decreasing we need
dx
to compute its first derivative 2 and show that it is
dx1
negative.
dx2 C
=− 0
( x1 )
2
dx1

since C  0 and ( x1 )  0. Thus, an indifference curve

2

is decreasing.
To show that an indifference curve is convex we need to
d 2 x2
compute its second derivative and show that it is
d ( x1 )
2

positive.
d 2 x2 C
= 0
d ( x1 ) 2 ( x1 )
2 3

for x1  0. Thus, the indifference curve is convex.

a.(2) u2 ( x1 , x2 ) = ln x1 + x2
1
MU1 =
x1
MU 2 = 1
1
MRS =
x1
These preferences are monotone by the same argument
as above.
An indifference curve is described by
ln x1 + x2 = u
Equivalently
x2 = u − ln x1
dx2 1
= −  0 for x1  0
dx1 x1
Thus, the indifference curve is decreasing.
d 2 x2 1
= 0
d ( x1 ) ( x1 )
2 2

Thus, the indifference curve is convex.

a.(3) u3 ( x1 , x2 ) = ln x1 + ln x2
1
MU1 =
x1
1
MU 2 =
x2
x2
MRS =
x1
These preferences are monotone by the same argument
as above.
An indifference curve is described by
ln x1 + ln x2 = u
ln x2 = u − ln x1
exp ( ln x2 ) = exp ( u − ln x1 )
exp(u )
x2 =
exp ( ln x1 )
C
x2 =
x1
where C = exp u
C
The indifference curve is x2 = . Observe the similarity
x1
with the first utility function.
dx2 C
=− 0
( x1 )
2
dx1

since C  0 and ( x1 )  0. Thus, an indifference curve

2

is decreasing.
d 2 x2 C
= 0
d ( x1 ) 2 ( x1 )
2 3

for x1  0. Thus, the indifference curve is convex.

a.(4) u4 ( x1 , x2 ) = min 2 x1 , x2 
First, we observe that function u4 is not differentiable at a point (t , 2t ) for any t  0
MU1 = 0 if 2 x1  x2
2 if 2 x1  x2
undefined if 2 x1 = x2
MU 2 = 1 if 2 x1  x2
0 i f 2 x1  x2
undefined if 2 x1 = x2
MRS = 0 if 2 x1  x2
- if 2 x1  x2
undefined if 2 x1 = x2
These preferences are monotone by the same argument
as above.
An indifference curve is described by
min 2 x1 , x2  = u
Equivalently
x2 = u if 2 x1  x2
u
x1 = if 2 x1 = x2
2
In the case of Leontief preferences we need to adhere to
the graph of the indifference curve to determine whether
an indifference curve is decreasing. On the segment 2 x1 
x2 the value of x2 is constant and equals to u. On the
segment 2 x1  x2 , x2 can take any value that is greater
or equal to u. Thus, an indifference curve is decreasing.
An indifference curve is convex since its upper contour set
(a set of points that lie above the graph of an indifference
curve) is a convex set.
b. A monotone transformation of a given utility function will yield
a new utility function that represents the same preferences.
Confider the following monotone transformation
f (u ) = exp(u )
We obtain
u new ( x1 , x2 ) = exp ( u3 )
= exp ( ln ( x1 ) + ln ( x2 ) )
= exp ( ln ( x1 x2 ) )
= x1 x2
Thus, utility u new ( x1 , x2 ) = x1 x2 represents the same preferences
as utility function u3 ( x1 , x2 ) = ln ( x1 ) + ln ( x2 ) . The relevant
monotone transformation is f (u ) = exp(u )
Question 6
since the consumer likes to consume jam and bagel in fixed propor-
tions, those two goods are perfect complements to him. The utility
function that represents his preferences is given by
u ( xb , x j ) = min 3xb , x j 
where xb is the consumption of bagels and x j is the consumption of
jam.
since the goods are perfect complements, at the optimum they will
be consumed in the fixed proportion given by the utility function. In
this example 3 xb = x j . If the equality is not satisfied, function. In
consumer chooses a bundle where 3 xb  x j , he can give up some of
the consumption of jam without effecting the utility. He can then use
that money to buy some more bagels and strictly improve his utility.
Thus at the original point where 3 xb  x j he was not maximizing his
utility.
Now, that we have established that at the optimum 3 xb = x j , we will
use that equality and the budget line to find the optimal consumption
allocation. The two equations are
3xb = x j
xb pb + x j p j = m
 xb pb + 3xb p j = m
m
 xb =
pb + 3 p j
3m
xj =
pb + 3 p j
Question 7

a.The Lagrange function is:

1
= x1 − x12 + x2 +  ( I − p1 x1 − p2 x2 )
2
First-order conditions:
1 = 1 − x1 −  p1 =0
2 = 1 −  p2 =0
 = I − p1 x1 − p2 x2 = 0

( Do not worry about the fact that this utility function is decreasing in x1
for large values of x1; simply proceed as if prices and income are such
that the solution is interior.)

b.We need to solve the first-order conditions for the demand function of
good 1 in order to solve this problem. Doing this gives you
p
x1 = 1 − 1
p2
(Notice that demand for x1 is only positive if p2  p1. Otherwise, we have
a corner solution.)

p1 dx1 p1
e=− =
x1 dp1 p2 − p1

Question 8

a.The budget constraint is c = w(T − h − kc)

b.The maximization problem is:

max c ,h ch subject to c = w(T − h − kc)
The lagrangian from this maximization problem is:
= ch +  (c − w(T − h − kc))
The fist order condition are then:
c + w = 0
h +  +  wk = 0
Solving these two equations for c gives the following demand function for consumption:
wT
c=
2(1 + wk )
 dc 2w2T
c. =− 0
dk 4(1 + wk ) 2
dc
since  0, the optimal consumption of c increases if k decreases. Another
dk
way of thinking about this is that since k is in the denominator, when k gets
smaller, the denominator gets smaller, and the entire expression for c gets bigger.
The common saying "time is money" does make sense.