University of Exeter

Department of Economics
Pauline Vorjohann
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BEEM101 Microeconomics
Problem Set 3: Consumer behavior
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1. Exercise - The consumer’s choice problem

Consider a consumer who is endowed with wealth w. The consumer faces prices p1 for good 1 and
p2 for good 2.

a) Sketch the consumer’s budget set and budget line.

b) Suppose the government imposes a quantity tax t on good 2. How does the budget set change?
c) Suppose the government instead charges a value tax of τ on good 2. How does the budget set
change?
d) What happens to the budget set if the government grants a lump sum subsidy of s?
e) What happens to the budget set if the government rations the amount of good 1 to x̄1 < w/p1 ?
f ) Finally, suppose the government taxes every unit of good 1 that exceeds x̄1 with a quantity tax
t. What happens to the budget set?

2. Exercise - Consumer demand

Let X = R2+ be the set of all bundles of two goods. Denote by x1 and x2 the amounts of goods 1 and
2 contained in bundle x ∈ X. Consider consumers with budget sets B(p1 , p2 , w) whose preference
relations on X are represented by the following utility functions. Derive each consumer’s demand
function.
1−α
a) u(x1 , x2 ) = xα
1 x2 with α ∈ (0, 1)
b) u(x1 , x2 ) = x1 + 3x2
c) u(x1 , x2 ) = min{4x1 , 2x2 }
√
d) u(x1 , x2 ) = x1 + x2