PROBLEMS 141
$1.50 per month. Each movie he attends costs $10. Let x
denote the square feet of housing, and let y denote the
number of movies he attends per month.
a) What is the expression for Pedro’s budget constraint?
b) Draw a graph of Pedro’s budget line.
c) What is the maximum number of square feet of hous-
ing he can purchase given his monthly stipend?
d) What is the maximum number of movies he could
attend given his monthly stipend?
e) Suppose Pedro’s parents increase his stipend by
10 percent. At the same time, suppose that in the college
town where he lives, all prices, including housing rental
rates and movie ticket prices, increase by 10 percent.
What happens to the graph of Pedro’s budget line?
4.2. Sarah consumes apples and oranges (these are the
only fruits she eats). She has decided that her monthly
budget for fruit will be $50. Suppose that one apple costs
$0.25, while one orange costs $0.50.
a) What is the expression for Sarah’s budget constraint?
b) Draw a graph of Sarah’s budget line.
c) Show graphically how Sarah’s budget line changes if
the price of apples increases to $0.50.
d) Show graphically how Sarah’s budget line changes if
the price of oranges decreases to $0.25.
e) Suppose Sarah decides to cut her monthly budget for
fruit in half. Coincidentally, the next time she goes to the
grocery store, she learns that oranges and apples are on
sale for half price, and will remain so for the next month;
that is, the price of apples falls from $0.25 per apple to to
$0.125 per apple, and the price of oranges falls from
$0.50 per orange to $0.25 per orange. What happens to
the graph of Sarah’s budget line?
4.3. Julie has preferences for food F and clothing C de-
scribed by a utility function U(F, C )  FC. Her marginal
utilities are MUF  C and MUC  F. Suppose that food
costs $1 a unit and that clothing costs $2 a unit. Julie has
$12 to spend on food and clothing.
a) On a graph draw indifference curves corresponding
to u  12, u  18, and u  24. Using the graph (and no
algebra), find the optimal (utility-maximizing) choice of
food and clothing. Let the amount of food be on the
horizontal axis and the amount of clothing be on the
vertical axis.
b) Using algebra (the tangency condition and the budget
line), find the optimal choice of food and clothing.
c) What is the marginal rate of substitution of food for
clothing at her optimal basket? Show this graphically and
algebraically.
d) Suppose Julie decides to buy 4 units of food and
4 units of clothing with her $12 budget (instead of the op-
timal basket). Would her marginal utility per dollar spent
on food be greater than or less than her marginal utility
per dollar spent on clothing? What does this tell you about
how she should substitute food for clothing if she wanted
to increase her utility without spending any more money?
4.4. The utility that Ann receives by consuming food F
and clothing C is given by U(F, C )  FC  F. The mar-
ginal utilities of food and clothing are MUF  C  1 and
MUC  F. Food costs $1 a unit, and clothing costs $2 a
unit. Ann’s income is $22.
a) Ann is currently spending all of her income. She is
buying 8 units of food. How many units of clothing is she
consuming?
b) Graph her budget line. Place the number of units of
clothing on the vertical axis and the number of units of
food on the horizontal axis. Plot her current consump-
tion basket.
c) Draw the indifference curve associated with a utility
level of 36 and the indifference curve associated with a
utility level of 72. Are the indifference curves bowed in
toward the origin?
d) Using a graph (and no algebra), find the utility-
maximizing choice of food and clothing.
e) Using algebra, find the utility-maximizing choice of
food and clothing.
f ) What is the marginal rate of substitution of food for
clothing when utility is maximized? Show this graphi-
cally and algebraically.
g) Does Ann have a diminishing marginal rate of substi-
tution of food for clothing? Show this graphically and
algebraically.
4.5. Consider a consumer with the utility function
U(x, y)  min(3x, 5y); that is, the two goods are perfect
complements in the ratio 3:5. The prices of the two goods
are Px  $5 and Py  $10, and the consumer’s income is
$220. Determine the optimum consumption basket.
4.6. Jane likes hamburgers (H) and milkshakes (M). Her
indifference curves are bowed in toward the origin and
do not intersect the axes. The price of a milkshake is $1
and the price of a hamburger is $3. She is spending all
her income at the basket she is currently consuming, and
her marginal rate of substitution of hamburgers for milk-
shakes is 2. Is she at an optimum? If so, show why. If not,
should she buy fewer hamburgers and more milkshakes,
or the reverse?
4.7. Ray buys only hamburgers and bottles of root beer
out of a weekly income of $100. He currently consumes
20 bottles of root beer per week, and his marginal utility
of root beer is 6. The price of root beer is $2 per bottle.
Currently, he also consumes 15 hamburgers per week,
and his marginal utility of a hamburger is 8. Is Ray max-
imizing utility at his current consumption basket? If not,
should he buy more hamburgers each week, or fewer?
142 CHAPTER 4 CONSUMER CHOICE
4.8. Dave currently consumes 10 hot dogs and 6 sodas
each week. At his current consumption basket, his mar-
ginal utility for hot dogs is 5 and his marginal utility for
sodas is 3. If the price of one hot dog is $1 and the price
of one soda is $0.50, is Dave currently maximizing his
utility? If not, how should he reallocate his spending in
order to increase his utility?
4.9. Helen’s preferences over CDs (C ) and sandwiches
(S) are given by U(S, C)  SC  10(S  C), with MUC 
S  10 and MUS  C  10. If the price of a CD is $9 and
the price of a sandwich is $3, and Helen can spend a com-
bined total of $30 each day on these goods, find Helen’s
optimal consumption basket.
4.10. The utility that Corey obtains by consuming
hamburgers (H) and hot dogs (S) is given by U(H, S) 
1H  1S  4. The marginal utility of hamburgers is
0.5 0.5 #
and the marginal utility of steaks is equal to
1H 1S  4
a) Sketch the indifference curve corresponding to the
utility level U  12.
b) Suppose that the price of hamburgers is $1 per ham-
burger and the price of steak is $8 per steak. Moreover,
suppose that Corey can spend $100 per month on these
two foods. Sketch Corey’s budget line for hamburgers
and steak given this budget.
c) Based on your answer to parts (a) and (b), what is
Corey’s optimal consumption basket given his budget?
4.11. This problem will help you understand what
happens if the marginal rate of substitution is not dimin-
ishing. Dr. Strangetaste buys only french fries (F ) and
hot dogs (H ) out of his income. He has positive marginal
utilities for both goods, and his MRSH,F is increasing. The
price of hot dogs is PH, and the price of french fries is PF.
a) Draw several of Dr. Strangetaste’s indifference curves,
including one that is tangent to his budget line.
b) Show that the point of tangency does not represent
a basket at which utility is maximized, given the budget
constraint. Using the indifference curves you have
drawn, indicate on your graph where the optimal basket
is located.
4.12. Julie consumes two goods, food and clothing, and
always has a positive marginal utility for each good. Her
income is 24. Initially, the price of food is 2 and the price
of clothing is 2. After new government policies are im-
plemented, the price of food falls to 1 and the price of
clothing rises to 4. Suppose, under the initial budget con-
straint, her optimal choice is 10 units of food and 2 units
of clothing.
a) After the prices change, can you predict whether her
utility will be higher, lower, or the same as under the
initial prices?
b) Does your answer require that there be a diminishing
marginal rate of substitution of food for clothing?
Explain.
4.13. Toni likes to purchase round trips between the
cities of Pulmonia and Castoria and other goods out of
her income of $10,000. Fortunately, Pulmonian Airways
provides air service and has a frequent flyer program. A
round trip between the two cities normally costs $500,
but any customer who makes more than 10 trips a year
gets to make additional trips during the year for only
$200 per round trip.
a) On a graph with round trips on the horizontal axis and
“other goods” on the vertical axis, draw Toni’s budget
line. (Hint: This problem demonstrates that a budget line
need not always be a straight line.)
b) On the graph you drew in part (a), draw a set of indif-
ference curves that illustrates why Toni may be better off
with the frequent flyer program.
c) On a new graph draw the same budget line you found
in part (a). Now draw a set of indifference curves that
illustrates why Toni might not be better off with the fre-
quent flyer program.
4.14. A consumer has preferences between two
goods, hamburgers (measured by H ) and milkshakes
(measured by M ). His preferences over the two goods
are represented by the utility function U  1H  1M.
For this utility function MUH  1/ (21H) and
MUM  1/(2/ 1M) .
a) Determine if there is a diminishing MRSH,M for this
utility function.
b) Draw a graph to illustrate the shape of a typical indif-
ference curve. Label the curve U1. Does the indifference
curve intersect either axis? On the same graph, draw a
second indifference curve U2, with U2  U1.
c) The consumer has an income of $24 per week. The
price of a hamburger is $2 and the price of a milkshake is
$1. How many milkshakes and hamburgers will he buy
each week if he maximizes utility? Illustrate your answer
on a graph.
4.15. Justin has the utility function U  xy, with the
marginal utilities MUx  y and MUy  x. The price of x
is 2, the price of y is py, and his income is 40. When he
maximizes utility subject to his budget constraint, he
purchases 5 units of y. What must be the price of y and
the amount of x consumed?
4.16. A student consumes root beer and a composite
good whose price is $1. Currently, the government im-
poses an excise tax of $0.50 per six-pack of root beer. The
student now purchases 20 six-packs of root beer per
month. (Think of the excise tax as increasing the price of
root beer by $0.50 per six-pack over what the price would

be without the tax.) The government is considering elimi-
nating the excise tax on root beer and, instead, requiring
consumers to pay $10.00 per month as a lump-sum tax
(i.e., the student pays a tax of $10.00 per month, regardless
of how much root beer is consumed). If the new proposal
is adopted, how will the student’s consumption pattern (in
particular, the amount of root beer consumed) and welfare
be affected? (Assume that the student’s marginal rate of
substitution of root beer for other goods is diminishing.)
4.17. When the price of gasoline is $2.00 per gallon,
Joe consumes 1,000 gallons per year. The price increases
to $2.50, and to offset the harm to Joe, the government
gives him a cash transfer of $500 per year. Will Joe be bet-
ter off or worse off after the price increase and cash trans-
fer than he was before? What will happen to his gasoline
consumption? (Assume that Joe’s marginal rate of substi-
tution of gasoline for other goods is diminishing.)
4.18. Paul consumes only two goods, pizza (P) and ham-
burgers (H), and considers them to be perfect substitutes,
as shown by his utility function: U(P, H)  P  4H. The
price of pizza is $3 and the price of hamburgers is $6, and
Paul’s monthly income is $300. Knowing that he likes
pizza, Paul’s grandmother gives him a birthday gift cer-
tificate of $60 redeemable only at Pizza Hut. Though
Paul is happy to get this gift, his grandmother did not
realize that she could have made him exactly as happy by
spending far less than she did. How much would she have
needed to give him in cash to make him just as well off as
with the gift certificate?
4.19. Jack makes his consumption and saving decisions
two months at a time. His income this month is $1,000,
and he knows that he will get a raise next month, making
his income $1,050. The current interest rate (at which he
is free to borrow or lend) is 5 percent. Denoting this
month’s consumption by x and next month’s by y, for each
of the following utility functions state whether Jack would
choose to borrow, lend, or do neither in the first month.
(Hint: In each case, start by assuming that Jack would sim-
ply spend his income in each month without borrowing
or lending money. Would doing so be optimal?)
a) U(x, y)  xy2, MUx  y2, MUy  2xy
b) U(x, y)  x2y, MUx  2xy, MUy  x 2
c) U(x, y)  xy, MUx  y, MUy  x
4.20. The figure in this problem shows a budget set for
a consumer over two time periods, with a borrowing rate
PROBLEMS 143
MRSC1, C2 will choose to borrow in the first period if at
basket A MRSC1, C2 7 1  rB and will choose to lend if at
basket A MRSC1, C2 6 1  rL. If the MRS lies between
these two values, then he will neither borrow nor lend.
(You can try to prove this if you like. Keep in mind that
diminishing MRS plays an important role in the proof.)
Using this rule, consider the decision of Meg, who
earns $2,000 this month and $2,200 the next with a utility
function given by U(C1, C2)  C1C2, where the C’s denote
the value of consumption in each month. For this utility
function MUC1  C2 and MUC2  C1. Suppose rL  0.05
(the lending rate is 5 percent) and rB  0.12 (the borrowing
rate is 12 percent). Would Meg borrow, lend, or do neither
this month? What if the borrowing rate fell to 8 percent?
C2
2,200 +
2,000(1.05) Slope = –1.05
A
2,200
Slope = –1.12
2,000 2,000 + 2,200/1.12 C1
4.21. Sally consumes housing (denote the number of
units of housing by h) and other goods (a composite good
whose units are measured by y), both of which she likes.
Initially she has an income of $100, and the price of a unit
of housing (Ph) is $10. At her initial basket she consumes
2 units of housing. A few months later her income rises
to $120; unfortunately, the price of housing in her city
also rises, to $15. The price of the composite good does
not change. At her later basket she consumes 1 unit of
housing. Using revealed preference analysis (without
drawing indifference curves), what can you say about how
she ranks her initial and later baskets?
4.22. Samantha purchases food (F ) and other goods
(Y ) with the utility function U  FY, with MUF  Y and
MUy  F. Her income is 12. The price of a food is 2 and
the price of other goods 1.
a) How many units of food does she consume when she
maximizes utility?
b) The government has recently completed a study sug-
rB and a lending rate rL, with rL  rB. The consumer pur-
chases C1 units of a composite good in period 1 and C2
units in period 2. The following is a general fact about
consumers making consumption decisions over two time
periods: Let A denote the basket at which a consumer
spends exactly his income each period (the point at the kink
of the budget line). Then a consumer with a diminishing
gesting that, for a healthy diet, every consumer should
consume at least F  8 units of food. The government is
considering giving a consumer like Samantha a cash sub-
sidy that would induce her to buy F  8. How large would
the cash subsidy need to be? Show her optimal basket
with the cash subsidy on an optimal choice diagram with
F on the horizontal axis and Y on the vertical axis.
144 CHAPTER 4
c) As an alternative to the cash subsidy in part (b), the
government is also considering giving consumers like
Samantha food stamps, that is, vouchers with a cash value
that can only be redeemed to purchase food. Verify that
if the government gives her vouchers worth $16, she will
choose F  8. Illustrate her optimal choice on an optimal
choice diagram. (You may use the same graph you drew
in part (b).)
4.23. As shown in the following figure, a consumer
buys two goods, food and housing, and likes both goods.
When she has budget line BL1, her optimal choice is
basket A. Given budget line BL2, she chooses basket B,
and with BL3, she chooses basket C.
A
Housing
B
C
BL1 BL2
Food
a) What can you infer about how the consumer ranks
baskets A, B, and C? If you can infer a ranking, explain
how. If you cannot infer a ranking, explain why not.
b) On the graph, shade in (and clearly label) the areas
that are revealed to be less preferred to basket B, and ex-
plain why you indicated these areas.
c) On the graph, shade in (and clearly label) the areas
that are revealed to be (more) preferred to basket B, and
explain why you indicated these areas.
4.24. The following graph shows the consumption
decisions of a consumer over bundles of x and y, both of
which he likes. When faced with budget line BL1, he
chose basket A, and when faced with budget line BL2, he
chose basket B. If he were to face budget line BL3, what
possible set of baskets could he choose in order for his
behavior to be consistent with utility maximization?
18
16
14
12
10 A
y BL3
8
6
4 B
2 BL2
BL1
0
2 4 6 8 10 12
x 2
CONSUMER CHOICE
4.25. Darrell has a monthly income of $60. He spends
this money making telephone calls home (measured in
minutes of calls) and on other goods. His mobile phone
company offers him two plans:
• Plan A: Pay no monthly fee and make calls for $0.50
per minute.
• Plan B: Pay a $20 monthly fee and make calls for
$0.20 per minute.
Graph Darrell’s budget constraint under each of the two
plans. If Plan A is better for him, what is the set of bas-
kets he may purchase if his behavior is consistent with
utility maximization? What baskets might he purchase if
Plan B is better for him?
4.26. Figure 4.17 illustrates the case in which a con-
sumer is better off with a quantity discount. Can you
draw an indifference map for a consumer who would not
be better off with the quantity discount?
4.27. Angela has a monthly income of $120, which she
spends on MP3s and a composite good (whose price you
may assume is $1 throughout this problem). Currently,
BL3 she does not belong to an MP3 club, so she pays the
retail price of an MP3 of $2; her optimal basket includes
20 MP3s monthly.
For the past several months Asteroid, a media com-
pany, has offered her the chance to join their “Premium
Club”; to join the club she would need to pay a member-
ship fee of $60 per month, but then she could buy all the
MP3s she wants at a price of $0.50. She has decided not
to join the club.
Asteroid has now introduced an “Economy Club”;
to join, Angela would need to pay a membership fee of
$30 per month, but then she could buy all the MP3s she
wants at a price of $1. Draw a graph illustrating
(1) Angela’s budget line and optimal basket when she joins
no club, (2) the budget line she would have faced had
she joined the Premium Club, and (3) her budget line if
she joins the Economy Club. Will Angela surely want to
join the Economy Club? If she were to join the club,
how many MP3s per month might she buy? Show how
you arrive at your answers using a revealed preference
argument.
4.28. Alex buys two goods, food (F ) and clothing (C ).
He likes both goods. His preferences for the goods do
not change from month to month. The following table
shows his income, the baskets he selected, and the prices
of the goods over a two-month period.
Month PF PC Income Basket Chosen
14 16 18 20
1 3 2 48 F  16, C  0
2 4 48 F  14, C  5
 A P P E N D I X 1 : T H E M AT H E M AT I C S O F C O N S U M E R C H O I C E 145

a) On the graph with F on the horizontal axis and C on
the vertical axis, plot and clearly label the budget lines
and consumption baskets during these two weeks. Label
the consumption bundle in week 1 by point A on the
graph and the consumption basket in week 2 by point B.
Using revealed preference analysis, what can you say
about Alex’s preferences for baskets A and B (i.e., how
does he rank them)?
b) In month 3 Alex’s income rises to 57. The prices of
food and clothing are both 3. Assuming his preferences
do not change, describe the set of baskets he might con-
sume in month 3 if he continues to maximize utility.
Show this set of baskets in the graph.
4.29. Brian consumes units of electricity (E ) and a
composite good (Y ), whose price is always 1. He likes
both goods.
In period 1 the power company sets the price of
electricity at $7 per unit, for all units of electricity con-
sumed. Brian consumes his optimal basket, 20 units of
electricity and 70 units of the composite good.
In period 2 the power company then revises its
pricing plan, charging $10 per unit for the first 5 units
and $4 per unit for each additional unit. Brian’s income
is unchanged. Brian’s optimal basket with this plan in-
cludes 30 units of electricity and 60 units of the com-
posite good.
In period 3 the power company allows the consumer
to choose either the pricing plan in period 1 or the plan
in period 2. Brian’s income is unchanged. Which pricing
plan will he choose? Illustrate your answer with a clearly
labeled graph.
4.30. Carina consumes two goods, X and Y, both of
which she likes. In month 1 she chooses basket A given
budget line BL1. In month 2 she chooses B given budget
line BL2, and in month 3 she chooses C given budget line
BL3. Assume her indifference map is unchanged over
the three months. Use the theory of revealed preference
to show whether her choices are consistent with utility-
maximizing behavior. If so, show how she ranks the three
baskets. If it is not possible to infer how she ranks the
baskets, explain why not.
Y
B
A
BL1
C
BL2 BL3 X

APPENDIX 1: The Mathematics of Consumer Choice

In this section we solve the consumer choice problem using the calculus technique of
Lagrange multipliers. Suppose the consumer buys two goods, where x measures the
amount of the first good and y the amount of the second good. The price of the first
good is Px and the price of the second is Py. The consumer has an income I.
Let’s assume that the marginal utilities of both goods are positive, so we know that he
will expend all of his income at his optimal basket. The consumer choice problem is then:

max U(x, y) (A4.1)

(x, y)

subject to: Px x  Py y  I

We define the Lagrangian (¶) as ¶(x, y, l)  U(x, y)  l(I  Px x  Py y), where  is

a Lagrange multiplier. The first-order necessary conditions for an interior optimum
(with x  0 and y  0) are

0¶ 0U (x, y)
01  lPx (A4.2)
0x 0x

0¶ 0U (x, y)
01  lPy (A4.3)
0y 0y
0¶
 0 1 I  Px x  Py y  0 (A4.4)
0l
200 CHAPTER 5 T H E T H E O RY O F D E M A N D
PROBLEMS
5.1. Figure 5.2(a) shows a consumer’s optimal choices
of food and clothing for three values of weekly income:
I1  $40, I2  $68, and I3  $92. Figure 5.2(b) illustrates
how the consumer’s demand curve for food shifts as in-
come changes. Draw three demand curves for clothing
(one for each level of income) to illustrate how changes
in income affect the consumer’s purchases of clothing.
5.2. Use the income consumption curve in Figure 5.2(a)
to draw the Engel curve for clothing, assuming the price
of food is $2 and the price of clothing is $4.
5.3. Show that the following statements are true:
a) An inferior good has a negative income elasticity of
demand.
b) A good whose income elasticity of demand is negative
will be an inferior good.
5.4. If the demand for a product is perfectly price in-
elastic, what does the corresponding price consumption
curve look like? Draw a graph to show the price con-
sumption curve.
5.5. Ann consumes five goods. The prices of all goods
are fixed. The price of good x is px. She spends 25 percent
of her income on good x, regardless of the size of her
income.
a) Show that her income elasticity of demand of good x
is the same for any level of income, and determine its
value.
b) Would the value of the income elasticity of demand
for x be different if Ann always spends 60 percent of her
income on good x?
5.6. Suzie purchases two goods, food and clothing. She
has the utility function U(x, y)  xy, where x denotes the
amount of food consumed and y the amount of cloth-
ing. The marginal utilities for this utility function are
MUx  y and MUy  x.
a) Show that the equation for her demand curve for
clothing is y  I Ⲑ(2Py).
b) Is clothing a normal good? Draw her demand curve
for clothing when the level of income is I  200. Label
this demand curve D1. Draw the demand curve when I 
300 and label this demand curve D2.
c) What can be said about the cross-price elasticity of
demand of food with respect to the price of clothing?
5.7. Karl’s preferences over hamburgers (H ) and beer
(B) are described by the utility function: U(H, B) 
min(2H, 3B). His monthly income is I dollars, and he
only buys these two goods out of his income. Denote the
price of hamburgers by PH and of beer by PB.
a) Derive Karl’s demand curve for beer as a function of
the exogenous variables.
b) Which affects Karl’s consumption of beer more: a one
dollar increase in PH or a one dollar increase in PB?
5.8. David has a quasilinear utility function of the form
U(x, y )  1x  y, with associated marginal utility func-
tions MUx  1/(21x ) and MUy  1.
a) Derive David’s demand curve for x as a function of the
prices, Px and Py. Verify that the demand for x is inde-
pendent of the level of income at an interior optimum.
b) Derive David’s demand curve for y. Is y a normal
good? What happens to the demand for y as Px increases?
5.9. Rick purchases two goods, food and clothing. He
has a diminishing marginal rate of substitution of food
for clothing. Let x denote the amount of food consumed
and y the amount of clothing. Suppose the price of food
increases from Px1 to Px2. On a clearly labeled graph, illus-
trate the income and substitution effects of the price
change on the consumption of food. Do so for each of
the following cases:
a) Case 1: Food is a normal good.
b) Case 2: The income elasticity of demand for food is zero.
c) Case 3: Food is an inferior good, but not a Giffen good.
d) Case 4: Food is a Giffen good.
5.10. Reggie consumes only two goods: food and
shelter. On a graph with shelter on the horizontal axis
and food on the vertical axis, his price consumption curve
for shelter is a vertical line. Draw a pair of budget lines
and indifference curves that are consistent with this de-
scription of his preferences. What must always be true
about Reggie’s income and substitution effects as the result
of a change in the price of shelter?
5.11. Ginger’s utility function is U(x, y)  x 2y, with asso-
ciated marginal utility functions MUx  2xy and
MUy  x 2. She has income I  240 and faces prices Px 
$8 and Py  $2.
a) Determine Ginger’s optimal basket given these prices
and her income.
b) If the price of y increases to $8 and Ginger’s income
is unchanged, what must the price of x fall to in order
for her to be exactly as well off as before the change
in Py?
5.12. Ann’s utility function is U(x, y)  x  y, with as-
sociated marginal utility functions MUx  1 and MUy  1.
Ann has income I  4.
a) Determine all optimal baskets given that she faces
prices Px  1 and Py  1.
 PROBLEMS 201

b) Determine all optimal baskets given that she faces 5.17. The accompanying figure illustrates the change
prices Px  1 and Py  2. in consumer surplus, given by Area ABEC, when the
c) What is demand for y when Px  1 and Py  1? What price decreases from P1 to P2. This area can be divided
is demand for y when Px  1 and Py  1? What is demand into the rectangle ABDC and the triangle BDE. Briefly
for y when Px  1 and Py  1? Plot Ann’s demand for y
as a function of Py.
d) Repeat the exercises in (a), (b) and (c) for U(x, y) 
2x  y, with associated marginal utility functions MUx 
2 and MUy  1, and with the same level of income.
5.13. Some texts define a “luxury good” as a good for
which the income elasticity of demand is greater than 1.
Suppose that a consumer purchases only two goods. Can
both goods be luxury goods? Explain.
5.14. Scott consumes only two goods, steak and ale.
When the price of steak falls, he buys more steak and more
ale. On an optimal choice diagram (with budget lines and
indifference curves), illustrate this pattern of consumption.
5.15. Dave consumes only two goods, coffee and
doughnuts. When the price of coffee falls, he buys the
same amount of coffee and more doughnuts.
a) On an optimal choice diagram (with budget lines and
indifference curves), illustrate this pattern of consumption.
b) Is this purchasing behavior consistent with a quasi-
linear utility function? Explain.
5.16. (This problem shows that an optimal consump-
tion choice need not be interior and may be at a corner
point.) Suppose that a consumer’s utility function is
U(x, y)  xy  10y. The marginal utilities for this utility
function are MUx  y and MUy  x  10. The price of x
is Px and the price of y is Py, with both prices positive.
The consumer has income I.
a) Assume first that we are at an interior optimum. Show
that the demand schedule for x can be written as x 
I Ⲑ(2Px)  5.
b) Suppose now that I  100. Since x must never be neg-
ative, what is the maximum value of Px for which this
consumer would ever purchase any x?
c) Suppose Py  20 and Px  20. On a graph illustrating
the optimal consumption bundle of x and y, show that
since Px exceeds the value you calculated in part (b), this
corresponds to a corner point at which the consumer
purchases only y. (In fact, the consumer would purchase
y  IⲐPy  5 units of y and no units of x.)
d) Compare the marginal rate of substitution of x for y
with the ratio (Px ⲐPy) at the optimum in part (c). Does
this verify that the consumer would reduce utility if she
purchased a positive amount of x?
e) Assuming income remains at 100, draw the demand
schedule for x for all values of Px. Does its location de-
pend on the value of Py?
describe what each area represents, separately, keeping in
mind the fact that consumer surplus is a measure of how
well off consumers are (therefore the change in consumer
surplus represents how much better off consumers are).
(Hint: Note that a price decrease also induces an increase
in the quantity consumed.)
Demand
A B
P1
P2 E
C D
q1 q2
5.18. The demand function for widgets is given by
D(P)  16  2P. Compute the change in consumer
surplus when the price of a widget increases from $1 to $3.
Illustrate your result graphically.
5.19. Jim’s preferences over cookies (x) and other
goods ( y) are given by U(x, y)  xy with associated mar-
ginal utility functions MUx  y and MUy  x. His in-
come is $20.
a) Find Jim’s demand schedule for x when the price of y
is Py  $1.
b) Illustrate graphically the change in consumer surplus
when the price of x increases from $1 to $2.
5.20. Lou’s preferences over pizza (x) and other goods
( y) are given by U(x, y)  xy, with associated marginal
utilities MUx  y and MUy  x. His income is $120.
a) Calculate his optimal basket when Px  4 and Py  1.
b) Calculate his income and substitution effects of a de-
crease in the price of food to $3.
c) Calculate the compensating variation of the price
change.
d) Calculate the equivalent variation of the price
change.
5.21. Carina buys two goods, food F and clothing C,
with the utility function U  FC  F. Her marginal util-
ity of food is MUF  C  1 and her marginal utility of
202 CHAPTER 5 T H E T H E O RY O F D E M A N D
clothing is MUC  F. She has an income of 20. The price
of clothing is 4.
a) Derive the equation representing Carina’s demand for
food, and draw this demand curve for prices of food rang-
ing between 1 and 6.
b) Calculate the income and substitution effects on
Carina’s consumption of food when the price of food
rises from 1 to 4, and draw a graph illustrating these
effects. Your graph need not be exactly to scale, but it
should be consistent with the data.
c) Determine the numerical size of the compensating
variation (in monetary terms) associated with the in-
crease in the price of food from 1 to 4.
5.22. Suppose the market for rental cars has two seg-
ments, business travelers and vacation travelers. The de-
mand curve for rental cars by business travelers is Qb 
35  0.25P, where Qb is the quantity demanded by busi-
ness travelers (in thousands of cars) when the rental price
is P dollars per day. No business customers will rent cars
if the price exceeds $140 per day.
The demand curve for rental cars by vacation travel-
ers is Qv  120  1.5P, where Qv is the quantity de-
manded by vacation travelers (in thousands of cars) when
the rental price is P dollars per day. No vacation cus-
tomers will rent cars if the price exceeds $80 per day.
a) Fill in the table to find the quantities demanded in the
market at each price.
Market
Business Vacation Demand
Price (thousands of (thousands of (thousands of
($/day) cars/day) cars/day) cars/day)
100
90
80
70
60
50
b) Graph the demand curves for each segment, and draw
the market demand curve for rental cars.
c) Describe the market demand curve algebraically. In
other words, show how the quantity demanded in the
market Qm depends on P. Make sure that your algebraic
equation for the market demand is consistent with your
answers to parts (a) and (b).
d) If the price of a rental car is $60, what is the consumer
surplus in each market segment?
5.23. There are two types of consumers in a market for
sheet metal. Let P represent the market price.
The total quantity demanded by Type I consumers is
Q1  100  2P, for 0  P  50.
The total quantity demanded by Type II consumers is
Q2  40  P, for 0  P  40.
Draw the total market demand on a clearly labeled
graph.
5.24. There are two consumers on the market: Jim and
Donna. Jim’s utility function is U(x, y)  xy, with associated
marginal utility functions MUx  y and MUy  x. Donna’s
utility function is U(x, y)  x2y, with associated marginal
utility functions MUx  2xy and MUy  x2. Income of Jim
is IJ  100 and income of Donna is ID  150.
a) Find optimal baskets of Jim and Donna when price of
y is Py  1 and price of x is P.
b) On separate graphs plot Jim’s and Donna’s demand
schedule for x for all values of P.
c) Compute and plot aggregate demand when Jim and
Donna are the only consumers.
d) Plot aggregate demand when there is one more con-
sumer that has identical utility function and income as
Donna.
5.25. One million consumers like to rent movie videos
in Pulmonia. Each has an identical demand curve for
movies. The price of a rental is $P. At a given price, will
the market demand be more elastic or less elastic than the
demand curve for any individual? (Assume there are no
network externalities.)
5.26. Suppose that Bart and Homer are the only people
in Springfield who drink 7-UP. Moreover their inverse
demand curves for 7-UP are, respectively, P  10  4QB
and P  25  2QH, and, of course, neither one can con-
sume a negative amount. Write down the market demand
curve for 7-UP in Springfield, as a function of all possi-
ble prices.
5.27. Joe’s income consumption curve for tea is a verti-
cal line on an optimal choice diagram, with tea on the
horizontal axis and other goods on the vertical axis.
a) Show that Joe’s demand curve for tea must be down-
ward sloping.
b) When the price of tea drops from $9 to $8 per pound,
the change in Joe’s consumer surplus (i.e., the change in
the area under the demand curve) is $30 per month.
Would you expect the compensating variation and the
equivalent variation resulting from the price decrease to
be near $30? Explain.
5.28. Consider the optimal choice of labor and leisure
discussed in the text. Suppose a consumer works the first

8 hours of the day at a wage rate of $10 per hour, but
receives an overtime wage rate of $20 for additional time
worked.
a) On an optimal choice diagram, draw the budget con-
straint. (Hint: It is not a straight line.)
b) Draw a set of indifference curves that would make it
optimal for him to work 4 hours of overtime each day.
5.29. Terry’s utility function over leisure (L) and other
goods (Y ) is U(L, Y )  Y  LY. The associated marginal
utilities are MUY  1  L and MUL  Y. He purchases
other goods at a price of $1, out of the income he earns
PROBLEMS 203
c) a compensating variation of $50 per month
d) a compensating variation of $50 per month
e) an equivalent variation of $50 per month
f) an equivalent variation of $50 per month
5.33. Gina lives in Chicago and very much enjoys trav-
eling by air to see her mother in Italy. On the accompa-
nying graph, x denotes her number of round trips to Italy
each year. The composite good y measures her annual
consumption of other goods; the price of the composite
good is py, which is constant in this problem. Several in-
difference curves from her preference map are drawn,
from working. Show that, no matter what Terry’s wage
rate, the optimal number of hours of leisure that he con-
sumes is always the same. What is the number of hours
he would like to have for leisure?
5.30. Consider Noah’s preferences for leisure (L) and
other goods (Y ), U(L, Y )  1L  1Y . The associated
marginal utilities are MUL  1/(21L) and MUY 
1/(21Y ). Suppose that PY  $1. Is Noah’s supply of
labor backward bending?
5.31. Raymond consumes leisure (L hours per day) and
other goods (Y units per day), with preferences described
by U(L, Y )  L  21Y. The associated marginal utili-
ties are MUY  1 and MUL  1 / 1L. The price of other
goods is 1 euro per unit. The wage rate is w euros per
hour.
a) Show how the number of units of leisure Raymond
chooses depends on the wage rate.
b) How does Raymond’s daily income depend on the
wage rate?
c) Does Raymond work more when the wage rate rises?
5.32. Julie buys food and other goods. She has an in-
come of $400 per month. The price of food is initially
$1.00 per unit. It then rises to $1.20 per unit. The prices
of other goods do not change. To help Julie out, her
mother offers to send her a check each month to supple-
ment her income. Julie tells her mother, “Thanks, Mom.
If you would send me a check for $50 per month, I would
be exactly as happy paying $1.20 per unit as I would have
been paying $1.00 per unit and not receiving the $50
from you.” Which of the following statements is true?
Explain.
The increased price of food has:
a) an income effect of $50 per month
b) an income effect of $50 per month
with levels of utility U1  U2  U3  U4  U5. If she
spends all her income on the composite good, she can
purchase y* units, as shown in the graph. When the ini-
tial price of air travel is $1,000, she can purchase as many
as 18 round trips if she spends all her income on air travel
to Italy.
a) Make a copy of the graph, and use it to determine the
income and substitution effects on the number of round
trips Gina makes as the price of a round trip increases
from $1,000 to $3,000. Clearly label these effects on the
graph.
b) Using the graph, estimate the numerical size of the
compensating variation associated with the price increase.
You may refer to the graph to explain your answer.
c) Will the consumer surplus measured using Gina’s de-
mand for air travel to Italy provide an exact measure of
the monetary value she associates with the price increase?
In a sentence, explain why or why not.
y
y*
U5
U4
U3
U2
U1
0 x
2 4 6 8 10 12 14 16 18