Diploma Preparatory Course: Microeconomics

Mikhail Safronov

Lecture 1

Consumer’s Choice

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Administrative stuff

My name is Mikhail Safronov. E-mail: ms2329@cam.ac.uk.

If you have unresolved comments or questions, please feel free
to send me an e-mail!

Recommended textbook is

• Varian (2010): Intermediate Microeconomics, 8th edition [or

9th edition (2014)].

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What is economics
There are different definitions in various textbooks. Most of
them resemble the following:

Economics is the science that studies human behavior under

limited resources.

Let’s look at few examples that economists deal with:

Example 1. Jane goes to a shop with 4£ to buy sweets. She

has a choice between chocolate candies (priced at 1£ per
kilogram) and fruit gum candies (priced at 2£ per kilogram).
Jane buys two kg of chocolate and one kg of fruit gum candies.
Human behavior: Jane - she can choose what to buy. Limited
resources: Money.
If we understand her behavior, we can predict how it will
change, if price on chocolate candies increases by 20 percent.
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What is economics

There are different definitions in various textbooks. Most of

them resemble the following:

Economics is the science that studies human behavior under

limited resources.

Let’s look at few examples that economists deal with:

Example 2. Within the last two weeks, price on chocolate in

Cambridge increased by 20 percent. By how much the sales of
chocolates would drop?
To answer the question, we would need to analyze behavior of
Cambridge citizens. They make a choice similar to the previous
example - they have limited resource (money), and choose how
much chocolate to buy.

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What is economics

There are different definitions in various textbooks. Most of

them resemble the following:

Economics is the science that studies human behavior under

limited resources.

Let’s look at few examples that economists deal with:

Example 3. What happens if the government increases tax?

Example 4. What is the relationship between interest rates and
unemployment?
In both examples, there are humans whose behavior matters.
They face certain constraints.

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A systematic way to study economics
Economics is the science that studies human behavior under
limited resources.

That is, there are economic agents that make choices.

There are three parts in describing choices of economic agents:

1. Economic agents have objectives.

Consumers like certain goods (chocolate, shoes, ...)
Firms aim to increase profits.

2. There are constraints within which agents have to make

choices.

3. Given constraints, and objectives, economic agents optimize

and make choices.

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Relevant questions are hard!

For many relevant economic questions, it is very hard (if not

impossible) to fully describe behavior of all economic agents.
First, there may be too many of economic agents.
Second, even for one agent, it may be a hard task to fully
describe their behavior.
For example, suppose you go to a pizza place and see the
menu. How much time do you need to make a choice? Now
imagine the pizza place changes prices. How much time do
you need to make a choice under new prices? Under all
possible prices?
For the owner of pizza place who is choosing prices, predicting
your behavior is even harder. Same for an economist who
studies pizza places.

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Economic models

In economics, we use models.

We focus on few concepts that we think are the most relevant
for the question in mind.
We also make some simplifying assumptions.
Models allow to make predictions, that can be tested. If not
satisfied - change the model.

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This course

This course focusses on basic models of consumer and

producer choice. We will look at basic concepts of ’objectives’,
’constraints’, and techniques on how to solve agents’ problems
of making optimal choices.

First two lectures - consumer’s choice;

Next two lectures - producer’s choice.

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Consumption bundle

Consumer’s choice - usually refers to people buying goods.

We call the objects of consumer’s choice consumption bundles.

Assume we have n goods (chocolate bars, shoes, computers,

etc.). Then, consumer’s choice is described by n numbers.

x = (x1 , ..., xn ) is a consumption bundle containing n goods.

Let X ⊂ Rn+ be a set of all possible consumption bundles.

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Jane buys sweets

We have ”objectives” and ”constraints” for consumers. Let’s

discuss constraints. Recall Example 1:

Jane goes to a shop with 4£ to buy sweets. She has a choice

between chocolate candies (priced at 1£ per kilogram) and fruit
gum candies (priced at 2£ per kilogram). Jane buys two kg of
chocolate and one kg of fruit gum candies.
Jane’s consumption bundle is a list of two numbers (x1 , x2 ),
with x1 indicating the weight of chocolate candies, and x2 - fruit
gum candies.

The bundle (x1 , x2 ) costs 1 × x1 + 2 × x2 .

Jane can afford any bundle that satisfies x1 + 2x2 ≤ 4.

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Budget set
Jane has 4£, chocolate candies cost 1£ per kg, fruit gum
candies - 2£ per kg.

x2

x1 = 2, x2 = 1
x1 + 2x2 = 4
x1
4

Jane can afford any pair (x1 , x2 ), such that x1 + 2x2 ≤ 4.

All affordable bundles form the budget set. Shaded area on the
picture.

The line x1 + 2x2 = 4 is called a budget line. It is a boundary of

the budget set. 12/62
Budget Set - general

In the general case of two goods, the budget set looks as

follows:

A consumer who has a budget of m. Also referred to as an

income.

Two divisible goods with unit prices p1 and p2 .

Consumer chooses to buy x1 of the first good, and x2 of the

second good.

The set of possible bundles which are affordable: (x1 , x2 ) such

that p1 x1 + p2 x2 ≤ m.

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Budget Set - picture
x2

m
p2

p1 x1 + p2 x2 = m
m
x1
p1

Budget line p1 x1 + p2 x2 = m.
The budget line connects two points ( pm1 , 0) and (0, pm2 ) - that
correspond to spending all money on one good.
m p1
An equivalent formula for the budget line: x2 = p2 − p2 x1 . The
slope of the line is − pp12 .
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Budget Set - change in income

What happens if m increases to m + ∆m?

x2

m
p2 p1x1 + p2x2 = m + ∆m

p1 x1 + p2 x2 = m
m
x1
p1

New budget line p1 x1 + p2 x2 = m + ∆m. There is a parallel

shift outwards.
The slope − pp21 is the same. Question: Why?

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Budget Set - change in price
What happens if p1 increases to p1 + ∆p1 ?
x2

m
p2

p1 x1 + p2 x2 = m
m m
x1
p1 +∆p1 p1

New budget line (p1 + ∆p1 )x1 + p2 x2 = m.

Rotation around the point (0, pm2 ).
Question. What happens with the budget line, if all values
of income m, and prices p1 , p2 double?
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Objectives

We have ”objectives” and ”constraints” for consumers. Let’s

discuss objectives. Recall Example 1:

Jane goes to a shop with 4£ to buy sweets. She has a choice

between chocolate candies (priced at 1£ per kilogram) and fruit
gum candies (priced at 2£ per kilogram). Jane buys two kg of
chocolate and one kg of fruit gum candies.
Suppose a different person, Bob, would go to the shop with the
same amount of money, 4£. Same constraints. Will Bob make
the same choice as Jane? Maybe not.
Jane and Bob may have different tastes for goods.

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Preferences

We assume that given any two consumption bundles, x and y ,

the consumer can rank them according to her tastes, or
preferences.
The consumer can strictly prefer x to y , y to x, or be indifferent.

Respectively, the consumer will choose the bundle that has the
highest rank, that is, the most preferred one.

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Assumptions about preferences

To ensure “consistency” of preferences, the following

assumptions are imposed:

1. Preferences are complete: The consumer can compare any

two bundles.
2. Preferences are transitive: if the consumer prefers x to y
and y to z, then the consumer prefers x to z.
Otherwise, if the consumer prefers x to y , y to z, and z to x,
then what is the best bundle?
Looks similar to numbers... You can compare any two numbers
a and b. If a > b, b > c, then a > c.

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Utility function

There is a mathematical way to represent preferences, referred

to as utility function.

Varian:
A utility function is a way of assigning a number to
every possible consumption bundle such that
more-preferred bundles get assigned larger numbers
than less-preferred bundles.

That is, assign a function U(x) onto the set X of all possible
bundles. If a consumer prefers x to y , then U(x) > U(y ).
To describe consumer’s preferences, assign a number to each
bundle. Simpler than comparing bundles pairwise.

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Indifference curves

In case of two goods, it is often useful to describe utility function

by “indifference curves”.

Indifference curve that corresponds to a certain value U of

utility, consists of all the bundles that yield the same value U.

In other words, take any two points x, y on an indifference

curve - the consumer is indifferent between them.

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Indifference curve - an example
x2

(1, 2)

x1 + x2 = 3
x1

In the example with fruit gum and chocolate candies: Suppose

the consumer is indifferent between the types of candies, and
only cares about the total weight of a bundle:
U(x1 , x2 ) = x1 + x2 .
Consider y = (1, 2). Then, the line x1 + x2 = 1 + 2 = 3 is an
indifference curve, such that the consumer is indifferent
between y and any other point on the line.
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Map of indifference curves

x2

x1

We can draw multiple indifference curves on the same graph,

each representing different values of utility. Arrows denote
more preferred bundles. Can also indicate with utility values.
Indifference curves do not cross. Why?

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Perfect substitutes

x2

x1

In the above example, the consumer is willing to “substitute one

good for the other at a constant rate”. Such goods are called
perfect substitutes.

For the goods to be perfect substitutes, the (constant) rate of

substitution does not necessarily have to be one-to-one. The
rate can be any positive number.

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Perfect complements
x2
3 B u=3
u=2
1 A u=1
x1
1 3

Perfect complements are goods that are always consumed

together in fixed proportions.

For example, right and left shoes. The associated utility

function is U(x1 , x2 ) = min{x1 , x2 } - number of pairs of shoes.
Consider bundle A - point (1, 1) - one pair of shoes. The
indifference curve for that bundle has an ’L-shape’, with (1, 1) in
the corner.
Bundle B = (1, 3) lies on the same indifference curve. One
right shoe and three left shoes still make one pair of shoes.
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Further assumptions on preferences

Assumptions of completeness and transitivity ensure

“consistency” of preferences.

Let’s introduce more assumptions about preferences. These

new assumptions ensure that one has well-behaved
indifference curves.

The new assumptions are more restrictive, - we can easily find

cases that violate the new assumptions.

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Monotonic preferences
Preferences are monotonic, if the consumer always prefers to
have more of each good.
This assumption ensures that ICs have a downward slope.
Why?
x2

c2
All bundles strictly
better than (a1 , a2 )

a2

All bundles strictly

worse than (a1 , a2 )

c1 a1 x1

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Convex preferences
Preferences are convex, if for any two bundles, that yield the
same value of utility: U(x1 , x2 ) = U(y1 , y2 ), any weighted
average is at least as good.
On the graph, any weighted average lies on the line that
connects the x- and y -bundles

x2
(y1, y2) = (1, 5)

average = (4, 2)

(x1, x2) = (5, 1)

x1

Preferences are strictly convex, if weighted average is strictly

better. 28/62
Non-monotonic and non-convex preferences

x2 x2

X Y

A
X

x1 Y x1

On the left, preferences are convex but not monotonic: A

satiation point.

On the right, preferences are not convex but monotonic. An

example might be beer and milk.
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A common shape for an indifference curve

We usually assume that preferences are monotonic: ”More is

better”
and strictly convex: ”Average is better than extremes”.
The indifference curve looks like this:

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Indifference curves help to optimize choice
Suppose a consumer chooses point (x1 , x2 ). Then, the
consumer thinks to, say, decrease consumption of first good
and instead buy second good. If such change increases utility -
consumer does this trade.

(x1, x2)

Indifference curves indicate whether a change in consumption

increases utility. In other words, ICs tell us the individual’s
“exact willingness” to substitute one good for the other.
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Focus on the indifference curve of bundle (x1 , x2 )
Let dx2 be the amount of change in second good to compensate
exactly for the change of dx1 in first good:

U(x1 , x2 ) = U(x1 + dx1 , x2 + dx2 )

MRS = slope of the tangent

(x1, x2)

(x1 + dx1, x2 + dx2)

If dx1 , dx2 become small, the ratio dx2 /dx1 would correspond to the
slope of the indifference curve at (x1 , x2 ).
This is called the Marginal Rate of Substitution, or MRS. Important
when estimating whether small changes in consumption increase
utility. 32/62
MRS

MRS shows the relative value of goods, as their consumption

changes (by a small amount).
Note that MRS depends on x1 , x2 .
Assume the (absolute) value of MRS is big. Which good is
relatively more important?

MRS = slope of the tangent

(x1, x2)

(x1 + dx1, x2 + dx2)

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Marginal utility

Let’s see what happens with utility, U(x1 , x2 ), as we change x1

by dx1 , and x2 by dx2 .
Change dx1 causes utility to change by U1 dx1 , where U1 is the
partial derivative with respect to x1 .
That is, U1 = ∂U(x1 ,x2 )
∂x1 - tells by how much utility changes with
x1 , as the amount of the other good, x2 , remains the same.
Also denoted as MU1 - marginal utility.
Similarly, as we change x2 by dx2 , utility changes by U2 dx2 . The
partial derivative, U2 = ∂U(x1 ,x2 )
∂x2 , can also be denoted as MU2 .

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Calculating MRS
dx2
MRS is the slope of the indifference curve. That is, dx1 .

MRS = slope of the tangent

(x1, x2)

(x1 + dx1, x2 + dx2)

However, since we stay on the same indifference curve,

dx2
U1 dx1 + U2 dx2 = 0. That is, MRS = dx 1
= −U1
U2
In other words, MRS - “relative value of importance of two
goods” - is the ratio of “importance” of each good for utility.

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Cobb-Douglas utility function

An important example of a utility function is Cobb-Douglas

function. An example of such a function is U(x1 , x2 ) = x1 x2 .
Below is the graph:
x2
5

1 u=5
u=3
u=1x
1
1 3 5

The MRS is: MRS1,2 (x1 , x2 ) = − U 1 (x1 ,x2 ) x2

U2 (x1 ,x2 ) = − x1
As we slide down along indifference curves, the slope
decreases.

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Quasilinear utility function
Another important example is quasilinear utility:
U(x1 , x2 ) = v (x1 ) + x2 . Useful when we have more than two
goods and want to focus on consumption of only one good. The
second good is usually assumed to be money. Below is the
√
graph for U(x1 , x2 ) = x1 + x2 .
x2
4

2 u=4

u=3

u=1 u=2
x1
0 2 4

MRS1,2 (x1 , x2 ) = − U 1 (x1 ,x2 ) 0 1

U2 (x1 ,x2 ) = −v (x1 ) = − 2 x1
√

The slope does not depend on x2 ! That is, ICs are copies of
each other, with a vertical shift. Note also that ICs touch the
axis. And that sliding down an IC decreases its slope. 37/62
Convex preferences and MRS

For both Cobb-Douglas and quasilinear utility, MRS decreases

in absolute value as x1 increases.
As consumption of one of the good increases, it becomes less
valuable as compared to the other good.
This is the consequence of convex preferences. If you prefer
mixture to extremes, you are willing to sacrifice more of the
good you have a lot of, in order to obtain a bit more of the good
you have little of.

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More about utility

Assume Jane has utility: U(x1 , x2 ) = x1 x2 . Jane can rank

bundles (x1 , x2 ) accordingly.
Suppose Bob has utility V (x1 , x2 ) = 2U(x1 , x2 ) = 2x1 x2 . Is
Bob’s ranking of bundles different? No! If for two bundles
(x1 , x2 ), (y1 , y2 ) one would have x1 x2 > y1 y2 , then one would
also have 2x1 x2 > 2y1 y2 .
Jane and Bob would make the same choices!
A utility is a numerical indicator of how the consumer ranks
bundles. Utility is designed to compare bundles. Utility value at
a single bundle: U(x) = 5 - tells nothing about preferences (or
well-being).

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Monotone transformation

Take any strictly increasing function f (y ):

√
f (y ) = 2y , f (y ) = y 2 , f (y ) = y + 1, f (y ) = y . If utility U(x1 , x2 )
represents preferences, then f (U(x1 , x2 )) - a new function -
represents the same preferences!
√ p √
If f (y ) = y - then W (x1 , x2 ) = U(x1 , x2 ) = x1 x2 represents
the same preferences as U(x1 , x2 ).
Monotone transformations do not change the MRS! That is, we
have the same map of indifference curves.
For example, let’s calculate MRS for W (x1 , x2 ):
√1 x
W1 (x1 ,x2 ) 2 x1 x2 2
MRS1,2 (x1 , x2 ) = − W 2 (x1 ,x2 )
=− √1 x
= − xx12 . The red part
2 x1 x2 1

corresponds to derivative of f (y ). Same result as with U(x1 , x2 )!

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“Diminishing Marginal Utility”

You can hear expression of sort: “marginal utility decreases”.

For example, “my marginal utility of consuming apples
decreases as I consume more apples”.
Consider a utility function with diminishing MU. Will MU remain
decreasing if you do a monotone transformation? Not
necessarily!
What is meant is that MRS is decreasing - that is, the ratio of
MU-s. That is, as my consumption of apples increases, I start
valuing additional units of oranges more as compared to
apples.

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Optimal Choice

The consumer chooses the most preferred bundle in the budget

set.

Can write it as

max U(x1 , x2 ) subject to p1 x1 + p2 x2 ≤ m

How to find the solution?

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Monotonic preferences

If preferences (and utility) are monotonic, then the optimal

choice lies on the budget line. Why?
m p1
That is, p1 x1 + p2 x2 = m, or, equivalently, x2 = p2 − p2 x1 .
But where on the budget line is utility maximized?

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Cobb-Douglas utility

Let’s look at an example. Utility function is Cobb-Douglas:

U(x1 , x2 ) = x1 x2 . The consumer has income m = 8; prices on
goods are p1 = 1, p2 = 2. That is, the budget line is
x1 + 2x2 = 8.
How to find the optimal choice? Several methods, which
essentially exploit the first-order condition:
Substitution: set x1 = 8 − 2x2 , and rewrite utility as
U(x2 ) = x2 (8 − 2x2 ).
Calculate the first derivative dU/dx2 = 8 − 4x2 , and set it to
zero. That is, x2∗ = 2. Respectively, x1∗ = 4.

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Another method - of Langrange multipliers:
Set up a Lagrangian:

L = x1 x2 + λ(8 − x1 − 2x2 )

Write first-order conditions:

∂L/∂x1 = x2 − λ = 0
∂L/∂x2 = x1 − 2λ = 0

Hence, x1 = 2x2 . Substituting it into budget constraint, we get

x1∗ = 4, x2∗ = 2.

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First-order condition - picture
Let’s indicate our solution on the picture. Below is the map of
indifference curves.

x2
10

U (x1, x2) = x1x2

8
BL : x1 + 2x2 = 8

4
BL

2
A u = 12
u=8
u=4x
1
2 4 6 8 10

Where is the optimal choice? It is point A = (4, 2). Note that the
IC (u = 8) touches the BL at A.
When using the first-order conditions, we found the optimal
point A - where IC touches BL.
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MRS and price ratio
x2
10

U (x1, x2) = x1x2

8
BL : x1 + 2x2 = 8

4
BL

2
A u = 12
u=8
u=4x
1
2 4 6 8 10

At point A slope of the IC equals MRS. BL is written as

x2 = pm2 − pp12 x1 , hence its slope is − pp12 .
Hence, MRS = − pp21 .
We can use it to solve the problem (third way to use the FOC).
Write MRS = − xx21 = − pp21 = − 12 .
That is, x1 = 2x2 . Substitute it into the BL, get x1∗ = 4, x2∗ = 2.
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An important condition

Hence, MRS = − pp21 . If this condition determines the optimal

choice, then we can find the solution as follows:
p1
Write MRS = − MU
MU2 = − p2
1

Write budget line: p1 x1 + p2 x2 = m

Then solve the system of equations - get a solution!
Does MRS = − pp21 always hold for the optimal solution?

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An example where FOC fails

Consider utility function U(x1 , x2 ) = x12 + x22 . Suppose income

m = 4, and prices p1 = p2 = 1. That is, BL is x1 + x2 = 4.
How to find the optimal solution? Let’s use MRS = − pp21 . We
have
p1
MRS = − MU 2x1
MU2 = − 2x2 = − p2 = −1. That is, x1 = x2 = 2.
1

Is it the optimal solution? We got utility U(2, 2) = 22 + 22 = 8.

What if we spend all money on one good - set x1 = 4, x2 = 0?
Then, utility is U(4, 0) = 16!
We got a wrong answer. Why?

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Non-convex preferences
We saw ICs for non-convex preferences (beer and milk). The
function U(x1 , x2 ) = x12 + x22 corresponds to these.
Below we have ICs. Let’s also draw BL: x1 + x2 = 8.

x2
4 u = 16

u = x21 + x22
3 x1 + x2 = 4

u=8
2 A
u=4
1

u=1 BL

1 2 3 4 x1

BL touches an IC at point A = (2, 2). Is A the optimal choice?

No! A yields utility U = 8, while point (0, 4) yields U = 16.

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Convex preferences
In the previous example, the issue was non-convexity. Extreme
choices were better than the average ones, hence a corner
solution (spend all money on one good) was optimal.
If we have (strictly) convex preferences, do we have
MRS = − pp21 in the optimum? Not necessarily. Look at the
√
picture for ICs for quasilinear utility U(x1 , x2 ) = x1 + x2 . Given
the budget line, point (4, 0) is the optimum, although MRS is
not equal to price ratio.
x2
4

2 u=4

u=3

u=1 BL u=2
x1
0 2 4
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Importance of interior solution

Is there any use of MRS = − pp21 ? Yes, there is!

There are two cases. Either the optimal solution is the extreme
one (also called corner solution). Spend all money on one
good.
Or, the optimal solution is the interior one - that is, buy positive
amount of each good.
In the latter case, it has to be that MRS = − pp12 .

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Bang for the buck

Why is MRS = − pp21 at the interior optimum?

Recall that MRS = − MU

MU2 . Hence, can rewrite the equation as
1

MU1 MU2
p1 = p2 .

What is MU
p1 ? It shows by how much utility increases, if the
1

consumer spends a bit more money on the first good.

If the equation failed - for example, MU MU2
p1 > p2 , then the
1

consumer would sell good 2, buy good 1, and benefit!

Why is this logic not working for the corner solution?

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What to do

How to find the optimum then?

One way is to a) find out whether there are points on the budget
line that satisfy MRS = − pp12 , and then b) compare utility at
those points with utilities at two extreme points.
Highest utility -> optimal solution
Moreover, if preferences are strictly convex, if you find a
solution MRS = − pp12 , then it is guaranteed to be the optimum!
No need to look at extreme points.
Cobb-Douglas utility function represents strictly convex
preferences (almost). Quasilinear utility U(x1 , x2 ) = v (x1 ) + x2
represents strictly convex preferences, if function v (x1 ) has a
positive and decreasing slope, that is, v 0 (x1 ) > 0, v 00 (x1 ) < 0.

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Cobb-Douglas utility

The consumer’s problem is:

max U(x1 , x2 ) = x1a x2b a,b>0 subject to p1 x1 + p2 x2 ≤ m

ax1a−1 x2b
We have MRS1,2 (x1 , x2 ) = − MU
MU2 = −
1 ax2
= − bx .
bx1a x2b−1 1

p1 bx1 p1
Set it equal to price ratio: − ax
bx1 = − p2 . Hence, x2 =
2
a p2 .

Substitute it into the budget constraint: p1 x1 + p1 bxa1 = m.

a m b m
Hence, optimum x1∗ = a+b ∗
p1 . Respectively, x2 = a+b p2 .
Note the total amount spend on each good is proportional to
the degree in utility function.
1 2
For example, U(x1 , x2 ) = x13 x23 - spend one third of money on
good 1, and two thirds on good 2.

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Reading

Varian, Intermediate Microeconomics, chapters 1, 2, 3, 4, 5.

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Exercises to review the lecture

At the end of each lecture there are exercises that help to

review and understand the material. It also helps to review
exercises at the end of relevant chapters in Varian.

1. A budget line is given by p1 x1 + p2 x2 = m. The

government imposes a lump-sum subsidy of u, a quantity
tax t1 on good 1, and an ad valorem tax τ2 on good 2. Find
the condition on values u, t1 , τ2 such that the new budget
line coincides with the original budget line.
2. Does MRS1,2 (a1 , a2 ) = −p1 /p2 imply (a1 , a2 ) is optimal?
Explain why (not)?
3. If IC at a point on the budget line is tangent to the budget
line, what can we conclude about that point?

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An exercise. Find a mistake
Question. Suppose Bob has 100£ that he can spend to buy
sweets from shops A and B. Shop A charges an entrance fee
of 10£; and sells chocolate candies and ice-cream at prices of
5£ and 10£ per kilogram, respectively. Shop B charges an
entrance fee of 20£; and sells chocolate candies and ice-cream
(identical to the ones sold by shop A) at prices of 10£ and 5£
per kilogram. Plotting the weight of chocolate candies on the
horizontal axis, and weight of ice-cream on vertical axis, draw
Bob’s budget set.
Proposed Answer. If Bob goes to shop A, he is left with 90£ to
spend, and the associated budget line is 5x + 10y = 90, that is,
x + 2y = 18. If Bob goes to shop B, he is left with 80£ to
spend, and the associated budget line is 10x + 5y = 80, that is,
2x + y = 16. The overall budget line is a ’maximum’ of the two
above lines, which is as follows: for x ∈ [0, 14/3] one gets
2x + y = 16, and for x ∈ [14/3, 18] one gets x + 2y = 18.
Why is this answer wrong? Explain.
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An exercise. Drawing

1. Draw indifference curves of the utility function

u(x1 , x2 ) = −(x1 − a1 )2 − (x2 − a2 )2

Are the preferences described by this function monotone?
Convex?
2. Draw indifference curves of the utility function:
√
u(x1 , x2 ) = x1 + 2x2
Are the preferences described by this function monotone?
Convex? What can you tell about the looks of indifference
curves?

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Another exercise

1. Say the IC of the bundle (3, 4) is the set

{(x1 , x2 ) ∈ R2 | x1 , x2 ≥ 0, x1 x2 = 12}

1.1 Compute the MRS1,2 (3, 4).

1.2 Identify another bundle on the above indifference curve and
compute MRS1,2 at that point.
1.3 What happens to MRS1,2 for the bundles on this IC as x1
grows? Can you describe what’s happening in layman’s
terms?
2. Is it possible for MRS to be positive? If so, what kind of
preferences could these be? Give some interpretation (or
some realistic context) where we would see MRS is
possibly positive.

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Exercises. Monotonicity and convexity
1. For the following utility functions determine whether the
corresponding preferences are i) monotonic, ii) strictly
convex. Explain your answer.
1.1 u1 (x, y ) = min{x, 2y }, x, y ≥ 0;
1.2 u2 (x, y ) = min{x, 2y } + max{x, 2y }, x, y ≥ 0.
2. Question. Suppose Ann has preferences between two
divisible goods. It is known that one of Ann’s indifference
√
curves is described by the following relation: x2 = x1 ,
where x1 , x2 ≥ 0 are the amounts of the first, and the
second good, respectively. Is it possible for Ann’s
preferences to be monotonic? Is it possible for Ann’s
preferences to be strictly convex?
√
Proposed answer. Since x2 = x1 is a monotonic
function of x1 , the preferences are monotonic. Since
√
x2 = x1 is a concave function of x1 , the preferences are
not convex. Find two mistakes in the answer.
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Exercise. Importance of convexity
A consumer’s preferences over bundles of two divisible goods X and
Y are represented by utility function u(x, y ) = x + y 2 . Denote the
unit price of X by p, where p > 0. And let the unit price of Y be 1.
1. Draw at least three indifference curves for this consumer,
depicting x on the horizontal axis, and y on the vertical axis.
(Pay attention to the curvature of the curve!)
2. Suppose that buying the bundle (2, 5) exhausts the consumer’s
budget. Moreover, |MRSx,y (2, 5)| = p. Explain, in words, what
this statement means.
3. What can we say about this consumer’s most preferred bundle in
her budget set? How does the bundle (2, 5) relate to that most
preferred bundle?
4. For which values of p would this consumer spend all of her
budget on a single good? Explain briefly.
5. Construct another utility function, v (x, y ), with indifference
curves different from those for u(x, y ), and such that for any
price p, the optimal choice would coincide with the one for
u(x, y ).
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