20627 – International Economics

Assignment 1
Professor: José Luis Groizard

September 10, 2023

Due date: September 20

Consumer’s theory is a fundamental topic covered in the introductory Microeconomics

course, taught during the first year of the Economics degree program. The purpose of
this set of problems is to help students review and become more comfortable with the
foundational concepts needed to understand the demand side of the market. To succeed
in this endeavor, students should take the time to revisit previous course materials or refer
to the lecture slides provided for this subject. More in detail, students must understand:

• Several concepts such as indifference curves, budget line, marginal rate of substitution
(MRS) and opportunity cost.

• Two methods to get the demand curve, the tangency method (mostly used in this
course) and the Lagrangian method.

• The Marshallian demand and the relative demand functions.

• Various utility functions (i.e., Cobb-Douglas, perfect complements, perfect substi-

tutes, CES, or monotonous transformations).

• Homothetic preferences.

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1. Indifference curves
The utility that Julie receives by consuming food F and clothing C is given by
U (C, F ) = CF . For this utility function, the marginal utilities are M UC = F and
M UF = C.

(a) On a graph with C on the horizontal axis and F on the vertical axis, draw
indifference curves for U = 12, U = 18, and U = 24.
(b) Do the shapes of these indifference curves suggest that Julie has a diminishing
marginal rate of substitution of food for clothing? Explain.
(c) Using the marginal utilities, show that the M RS = F/C. What is the slope
of the indifference curve U = 12 at the basket with 6 units of clothing and 2
units of food ? What is the slope at the basket with 3 units of clothing and 4
units of food? Do the slopes of the indifference curves indicate that Julie has a
diminishing marginal rate of substitution of clothing for food? (Make sure your
answers to parts (b) and (c) are consistent!)

2. Consider an economy (Home) with 2 goods, Cloth (C) and Food (F ). All consumers
have same Cobb-Douglas utility function:

U (DC , DF ) = (DC )a (DF )b

with a, b > 0.

(a) Obtain the Marshallian demand functions of Cloth and Food (as functions of
income and prices).
(b) Obtain consumption shares and show that:

pC DC a
=
pC DC + pF DF a+b
and
pF DF b
=
pC DC + pF DF a+b
(c) Let p = pC /pF . What it is the relative demand of Cloth RD(p) = DC /DF at
Home?
(d) Does relative demand depends on income? Can you infer from this analysis that
richer people consume relatively more any of the goods? Or, do they consume
the same proportions than poorer people?
Hint: use the tangency condition (M RS = pC /pF ) or any other method.

3. The Cobb-Douglas utility function and its log transformation.

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 (a) Obtain the Marshallian and the relative demand when the utility function is
U (DC , DF ) = (DC )2 (DF )

(b) Obtain the Marshallian and the relative demand when the utility function is
ln U (DC , DF ) = 2 ln(DC ) + ln(DF )

4. Consider that preferences are linear (i.e., perfect substitutes): U (DC , DF ) = aDC +
bDF

(a) Assume that a = 5 and b = 1 and that pC = 4, pF = 1 and I = 10. Show

graphically the budget line and the indifference curve when consumers maximize
utility. How much Cloth and Food are consumed at this point? Why there is
no F ood consumption (i.e., corner solution)?
(b) Now, assume that the pC increases from 4 to 6. What would be the demand of
both goods? Why?
(c) What would be the demand for both goods when pC = 5?
(d) Use the previous results to infer the relative demand of Cloth RD(p)), being
p = pC /pF , using graphical analysis.

5. Consider that preferences are Leontief’s type (i.e., perfect complements): U (DC , DF ) =
min{aDC , bDF }

(a) Assume that a = 5 and b = 2, obtain the kink line and use the budget line to
solve for the Marshallian demand functions of Cloth and Food.
(b) Does the Food price affect the demand of Cloth? Or does the Cloth price affect
the demand of Food? Why?
(c) Obtain the relative demand of Cloth RD(p), being p = pC /pF , analytically.
(d) Does the relative demand depend on income? Does the relative demand depend
of relative prices?

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6. The CES utility function.
ρ
Suppose a person has a utility function given by U (DC , DF ) = [DC + DFρ ]1/ρ where
ρ is a number between −∞ and 1. This is called a constant elasticity of substitution
(CES) utility function. The marginal utilities for this utility function are given by
1
ρ −1
M UDC = [DC + DFρ ] ρ ρ−1
DC
1
ρ −1
M UDF = [DC + DFρ ] ρ DFρ−1

(a) Obtain the relative demand of Cloth, RD(p), being p = pC /pF , analytically
using the tangency method.
(b) Draw the relative demand when ρ is 1. What can be said about the substi-
tutability degree between Cloth and Food?
(c) Draw the relative demand when −∞ is 1. What can be said about the substi-
tutability degree between Cloth and Food?
(d) (Optional) Obtain the Marshallian demand functions of Cloth and Food using
the Langrangian method.