The Australian National University

ECON8025: Semester One, 2024

Tutorial 3 Questions
Dr Damien S. Eldridge

To be Discussed in Week 4 Tutorials.

(No assignment this week.)

A Note on Sources
These questions do not originate with me. They have either been influenced
by, or directly drawn from, other sources.

Key Concepts
Utility Function Representations of Preferences, Budget-Constrained Util-
ity Maximisation, Uncompensated (or Ordinary, or Marshallian, or Wal-
rasian) Demand Functions (or Correspondences), Uncompensated (or Ordi-
nary, or Marshallian, or Walrasian) Demand Curves, Engel Curves, Indirect
Utility Functions, Interior Solutions, Corner Solutions, Gossen’s condition.

Tutorial Questions
Tutorial Question 1
Suppose that a consumer has perfect complements, or Leontief, preferences
over bundles of non-negative amounts of each of two commodities. The
consumer’s consumption set is R2+ . The consumer’s preferences can be
represented by a utility function of the form U (x1 , x2 ) = min(x1 , x2 ).

1. Illustrate the consumer’s budget set.

2. Illustrate a representative indifference curve for the consumer.
3. Illustrate the consumer’s budget-constrained utility maximisation prob-
lem.

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 4. Illustrate the derivation of the consumer’s uncompensated demand
curve for commodity one.

5. Illustrate the derivation of the consumer’s Engel curve for commodity

one.

6. Find the algebraic expression for the consumer’s uncompensated de-

mand functions for commodity one and commodity two?

7. Find an algebraic expression for the consumer’s indirect utility func-

tion.

Tutorial Question 2
Suppose that a consumer has perfect substitutes preferences over bundles
of non-negative amounts of each of two commodities. The consumer’s con-
sumption set is R2+ . The consumer’s preferences can be represented by a
utility function of the form U (x1 , x2 ) = x1 + x2 .

1. Illustrate the consumer’s budget set.

2. Illustrate a representative indifference curve for the consumer.

3. Illustrate the consumer’s budget-constrained utility maximisation prob-

lem.

4. Illustrated the derivation of the consumer’s uncompensated demand

curve for commodity one.

5. Illustrate the derivation of the consumer’s Engel curve for commodity

one.

6. Find the algebraic expression for the consumer’s uncompensated de-

mand functions for commodity one and commodity two?

7. Find an algebraic expression for the consumer’s indirect utility func-

tion.

Tutorial Question 3
Suppose that a consumer has preferences over bundles of non-negative
amounts of each two goods, x1 and x2 , that can be represented by a Cobb-
Douglas utility function of the form

U (x1 , x2 ) = xα1 x1−α

2 ,

2
where 0 < α < 1. The consumer is a price taker who faces a price per
unit of good one that is equal to $p1 and a price per unit of good two
that is equal to $p2 . Answer each of the following questions. To keep
things relatively simple, focus only on interior solutions that exhaust the
consumer’s budget.

1. What is the consumer’s utility maximisation problem?

2. What conditions characterise the consumer’s optimal choice of con-

sumption bundle (assuming that it is an interior solution that ex-
hausts the consumer’s budget)?

3. What are the consumer’s uncompensated demand functions for good

one and good two?

4. Illustrate a representative uncompensated demand curve and a rep-

resentative Engel curve for each commodity

5. What is the consumer’s optimal utility level, given the budget con-
straint? (In other words, what is the consumer’s indirect utility func-
tion?)

Tutorial Question 4
Suppose that a consumer has preferences over bundles of non-negative
amounts of each two goods, x1 and x2 , that can be represented by a quasi-
linear utility function of the form
√
U (x1 , x2 ) = x1 + x2 .

The consumer is a price taker who faces a price per unit of good one that is
equal to $p1 and a price per unit of good two that is equal to $p2 . Answer
each of the following questions. To keep things relatively simple, focus only
on interior solutions that exhaust the consumer’s budget for the moment.
(We will look at the possibility of a corner solution in the next question.)

1. What is the consumer’s utility maximisation problem?

2. What conditions characterise the consumer’s optimal choice of con-

sumption bundle (assuming that it is an interior solution that ex-
hausts the consumer’s budget)?

3. What are the consumer’s uncompensated demand functions for good

one and good two?

4. Illustrate a representative uncompensated demand curve and a rep-

resentative Engel curve for each commodity

3
 5. What is the consumer’s optimal utility level, given the budget con-
straint? (In other words, what is the consumer’s indirect utility func-
tion?)

Tutorial Question 5
The previous budget-constrained utility maximisation problem (involving
one type of quasi-linear preferences) has a corner solution for some combina-
tions of prices and income. This solution involves the consumer purchasing
only commodity two and purchasing none of commodity one. There is no
corner solution in which the consumer purchases only commodity one and
none of commodity two.

1. What are the consumer’s demands for commodity one and commodity
two in the corner solution identified in this question?

2. What happens to the consumer’s marginal rate of substitution as the

amount of commodity one that is purchased goes to zero, assuming
that the consumer exhausts his or her budget? Compare this limiting
value of the marginal rate of substitution to the price ratio. Use this
comparison and a suitable “indifference-curve / budget-constraint”
diagram to find a condition on prices and income that identifies when
this corner solution will occur. If the only other possible solution is
the interior solution that you found in the previous question, under
what conditions will that interior solution occur?

3. What happens to the consumer’s marginal rate of substitution as the

amount of commodity two that is purchased goes to zero, assuming
that the consumer exhausts his or her budget? Compare this limiting
value of the marginal rate of substitution to the price ratio. Use this
comparison and a suitable “indifference-curve / budget-constraint”
diagram to argue that there cannot be a corner solution in which this
consumer purchases zero units of commodity two.

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Additional Practice Questions
Additional Practice Question 1
(This question is based on a utility maximisation problem that has pre-
viously been asked by Dr Thomas Wiseman.) Suppose that a consumer’s
preferences over bundles that consist of strictly positive amounts of Fish
and Seaweed can be represented by a utility function U : R2+ −→ R that is
defined by
U (F, S) = F eS .
If we restrict attention to bundles that contain strictly positive amounts of
both fish and seaweed, so that (F, S) ∈ R2++ , are these preferences quasi-
linear? Explain the reason, or reasons, for your answer.

Additional Practice Question 2

Suppose that a consumer has lexicographic preferences over bundles of
non-negative amounts of each of two commodities. The consumer’s con-
sumption set is R2+ . The consumer weakly prefers bundle a = (a1 , a2 ) over
bundle b = (b1 , b2 ) if either (i) a1 > b1 , or (ii) both a1 = b1 and a2 > b2 . In
any other circumstance, the consumer does not weakly prefer bundle a to
bundle b. These preferences cannot be represented by a utility function.

1. Find the uncompensated demand functions for commodity one and

commodity two.

2. Illustrate the uncompensated demand curves for commodity one and

commodity two.

3. Illustrate the Engel curves for commodity one and commodity two.

Additional Practice Question 3

Suppose that a consumer has preferences over bundles of non-negative
amounts of each two goods, x1 and x2 , that can be represented by a specific
case of a constant elasticity of substitution (CES) utility function of the
form 1
U (x1 , x2 ) = (xρ1 + xρ2 ) ρ .
The consumer is a price taker who faces a price per unit of good one that is
equal to $p1 and a price per unit of good two that is equal to $p2 . Answer
each of the following questions. To keep things relatively simple, focus only
on interior solutions that exhaust the consumer’s budget.

1. What is the consumer’s utility maximisation problem?

5
 2. What conditions characterise the consumer’s optimal choice of con-
sumption bundle (assuming that it is an interior solution that ex-
hausts the consumer’s budget)?
3. What are the consumer’s uncompensated demand functions for good
one and good two?
4. Illustrate a representative uncompensated demand curve and a rep-
resentative Engel curve for each commodity
5. What is the consumer’s optimal utility level, given the budget con-
straint? (In other words, what is the consumer’s indirect utility func-
tion?)

Additional Practice Question 4

Suppose that a consumer has preferences over bundles of non-negative
amounts of each two goods, x1 and x2 , that can be represented by a con-
stant elasticity of substitution (CES) utility function of the form
1
U (x1 , x2 ) = (α1 xρ1 + α2 xρ2 ) ρ .
This is a slightly more general version of a constant elasticity of substitution
(CES) utility function than the one that was employed in Additional Prac-
tice Question 3 on this tutorial problem set. There is a very precise sense in
which constant elasticity of substitution preferences are more flexible than
perfect substitutes preferences, generalised perfect substitutes preferences,
Leontief (or perfect complements) preferences, and Cobb-Douglas prefer-
ences. Each of the latter group of preferences is a special case of constant
elasticity of substitution preferences. This question asks you to show that
this is the case. It then goes on to ask you to show that generalised Leon-
tief (generalised perfect complements) preferences are a special case of an
alternative version of a CES utility function that is given by

1
U (x1 , x2 ) = β1ρ−1 xρ1 + β2ρ−1 xρ2 ρ .
1. Show that the general CES utility function becomes the generalised
perfect substitutes utility function,
U (x1 , x2 ) = α1 x1 + α2 x2 ,
when ρ = 1.
2. Show that the perfect substitutes utility function,
U (x1 , x2 ) = x1 + x2 ,
is a special case of the general CES utility function.

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 3. Show that, at any point (x1 , x2 ) ∈ R2++ , we have
limρ−→0 U (x1 , x2 ; α1 = γ, α2 = 1 − γ, 0 < γ < 1)
1
= limρ−→0 (γxρ1 + (1 − γ) xρ2 ) ρ

= xγ1 x1−γ
2 ,

and then use this fact to argue that the Cobb-Douglas utility function
is a special case of the general CES utility function when we restrict
our attention to consumption bundles that contain strictly positive
amounts of both commodities. (Hint: Use L’Hopital’s rule.)
4. Show that, when we restrict our attention to consumption bundles
that contain strictly positive amounts of both commodities, a repre-
sentative indifference curve for the general CES utility function for
bundles of two commodities becomes “L” shaped when ρ −→ −∞,
with the kink occurring at the point where x1 = x2 , and then use this
fact to argue that the Leontief (perfect complements) utility function,
U (x1 , x2 ) = min (x1 , x2 ) ,
is a special case of the general CES utility function. (Hint: Recall
that the slope of an indifference curve is given by minus one times
the appropriate marginal rate of substitution.) Show that, for the
general CES utility function, we have


 ∞ if x1 < x2 ,



α1
lim M RS1,2 (x1 , x2 ) = α2
if x1 = x2 ,
ρ−→−∞ 



0 if x1 > x2 .


Use this result to argue that the representative indifference curve has
the desired shape when x1 is placed on the horizontal axis and x2 is
placed on the vertical axis.)
5. Consider now the slightly different CES utility function for bundles
of two commodities that is given by1

1
U (x1 , x2 ) = β1ρ−1 xρ1 + β2ρ−1 xρ2 ρ .
1
Saito (2012, pp. 7–8 and 10–11) discusses both the general version of the CES
functional form that is employed in the first four parts of this question and the slightly
different version that is considered in this part (that is, part 5) of this question. The
reference details for Saito (2012) are: Saito, T (2012), “How do we get Cobb-Douglas
and Leontief functions from CES function: a lecture note on discrete and continuum
differentiated object models”, Journal of Industrial Organization Education 6(1), Article
2, Manuscript 1037.

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 Show that, when we restrict our attention to consumption bundles
that contain strictly positive amounts of both commodities, a rep-
resentative indifference curve for this different CES utility function
becomes “L” shaped when ρ −→ −∞, with the kink occurring at the
point where β1 x1 = β2 x2 , and then use this fact to argue that the
generalised Leontief (generalised perfect complements) utility func-
tion,
U (x1 , x2 ) = min (β1 x1 , β2 x2 ) ,
is a special case of this different CES utility function. (Hint: Recall
that the slope of an indifference curve is given by minus one times
the appropriate marginal rate of substitution.) Show that, for this
different general CES utility function, we have


 ∞ if β1 x1 < β2 x2 ,



lim M RS1,2 (x1 , x2 ) = 1 if β1 x1 = β2 x2 ,
ρ−→−∞ 



0 if β1 x1 > β2 x2 .


Use this result to argue that the representative indifference curve has
the desired shape when x1 is placed on the horizontal axis and x2 is
placed on the vertical axis.)

Remark 1 The greater flexibility of CES preferences over perfect substi-

tutes preferences, generalised perfect substitutes preferences, Leontief (or
perfect complements) preferences, and Cobb-Douglas preferences might some-
times be an advantage in applied economic analysis. In empirical work,
preference parameters are unknown. This suggests that if there is sufficient
data available, a general constant elasticity of substitution utility function
might be a better choice for empirical work than a perfect substitutes utility
function, generalised perfect substitutes utility function, Leontief (or perfect
complements) utility function, or Cobb-Douglas utility function, precisely
because it embodies these other preferences as special cases. The use of a
general CES utility function would allow the data to determine what values
should be taken by the unknown preference parameters in the general CES
utility function (or at least, the preference parameters that are free to vary).
However, this apparent gain does not come without a cost. The added flex-
ibility of the general CES utility function is generated by the introduction
of (at least) one additional parameter. This means that there is at least
one additional parameter that needs to be estimated, which will require a
greater number of observations if it is to be implemented (and involve fewer
degrees of freedom for any given number of observations). There are other
functional forms that are even more flexible than the general CES func-
tional form (in at least some sense) that can, and perhaps should, be used

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for empirical work if there is a sufficiently large number of observations
available in the data set being used.