(These are the instructors’ Solutions to the Maths for Economics Problems provided on MindTap)

Maths for Economics: Chapter 4: Problem Solutions

PROBLEM
1. In chapter 4 the total utility function 𝑇𝑇𝑇𝑇 = 100𝑄𝑄 − 5𝑄𝑄 2 was used. Would it matter for the decision-
making of a household if we were to write 𝑇𝑇𝑇𝑇 = 2,468 + 100𝑄𝑄 − 5𝑄𝑄 2 instead?

SOLUTION
The absolute level of utility does not matter, since there is no meaningful way to express how happy you
are. However, you should be able to tell whether you are happier in situation A than you are in situation
B or the other way around. This is possible with both utility functions in the same way.

PROBLEM
2. Imagine a consumer travelling outside of his home country but in the European Union with a mobile
telephone. For travelling abroad, she does not have a flat rate for telephone minutes or online access.
Telephone calls cost €0.20 per minute and each megabyte of data volume costs €0.50. Her overall
budget for telecommunication on this trip is limited to €10.

a. Please express this budget constraint in an equation and rearrange terms so that you can see the
telephone minutes she can afford as a linear function of the data volume she has used.
b. How high is the opportunity cost of another megabyte of data volume in minutes of telephone calls?
c. Show the budget constraint in a graph, where you measure the data volume on the horizontal axis
and telephone minutes on the vertical axis.
d. Show in an equation and in the graph the effect of a reduction in the budget from €10 to €8 for the
trip.
e. Imagine a new regulation of the EU that leaves the price of telephone calls the same but limits the
price to €0.40 for a megabyte of data volume when traveling in the European Union. How does this
change the constraint with a €8-budget?
f. Keep the budget at €10 and assume that the difference telephone company offers a tariff where
telephone minutes cost €0.25 but data volume only €0.40/megabyte. Show this in the equation and
your graph.

SOLUTION
a. The budget constraint is €10 = 0.25�𝑚𝑚𝑚𝑚𝑚𝑚
€
� × 𝑋𝑋2 [𝑚𝑚𝑚𝑚𝑚𝑚] + 0.4�𝑀𝑀𝑀𝑀
€
� × 𝑋𝑋1 [𝑀𝑀𝑀𝑀]

€
€10 0.5�𝑀𝑀𝑀𝑀 �
⇔ 𝑋𝑋2 = €
− €
× 𝑋𝑋1 [𝑀𝑀𝑀𝑀]
0.2�𝑚𝑚𝑚𝑚𝑚𝑚 � 0.2�𝑚𝑚𝑚𝑚𝑚𝑚 �
𝑚𝑚𝑚𝑚𝑚𝑚€
⇔ 𝑋𝑋2 = 50[𝑚𝑚𝑚𝑚𝑚𝑚] − 2.5 � 𝑀𝑀𝑀𝑀
�× 𝑋𝑋1 [𝑀𝑀𝑀𝑀]
b. As each unit of data volume costs €0.5 and each telephone minutes €0.2 each megabyte costs 2.5
times as much as a telephone minute. The opportunity cost is given by the relative prices as can be seen
in the equation from problem a).

c. If she were to devote her entire budget to telephone minutes, she could afford a maximum of
€10
€ = 50[𝑚𝑚𝑚𝑚𝑚𝑚] in telephone calls. This is the intersection with the vertical axis. To find the
0.2�𝑚𝑚𝑚𝑚𝑚𝑚 �

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intersection with the horizontal axis, divide the budget of €10 by the price of data volume to get the
maximum of 20 MB. She can also afford all the combinations of telephone minutes and megabytes that
are on the straight line connecting these two points. See the graph below with the grey line Tariff A.

d. The new budget constraint now is €8 = 0.2�𝑚𝑚𝑚𝑚𝑚𝑚

€
� × 𝑋𝑋2 [𝑚𝑚𝑚𝑚𝑚𝑚] + 0.5�𝑀𝑀𝑀𝑀
€
� × 𝑋𝑋1 [𝑀𝑀𝑀𝑀]
⇔ 𝑋𝑋2 = 40 − 2.5 × 𝑋𝑋1
See the blue line of Tariff B in the graph.

e. The budget is €8 = 0.20�𝑚𝑚𝑚𝑚𝑚𝑚

€
� × 𝑋𝑋2 [𝑚𝑚𝑚𝑚𝑚𝑚] + 0.4�𝑀𝑀𝑀𝑀
€
� × 𝑋𝑋1 [𝑀𝑀𝑀𝑀]
⇔ 𝑋𝑋2 = 40 − 2 × 𝑋𝑋1
See the red Tariff C in the graph.

f. The budget is €10 = 0.25�𝑚𝑚𝑚𝑚𝑚𝑚

€
� × 𝑋𝑋2 [𝑚𝑚𝑚𝑚𝑚𝑚] + 0.4�𝑀𝑀𝑀𝑀
€
� × 𝑋𝑋1 [𝑀𝑀𝑀𝑀]
⇔ 𝑋𝑋2 = 40 − 1.6 × 𝑋𝑋1
See the green Tariff D in the graph.

Telephone minutes (X2)

50.00

40.00
Tariff A
Tariff B
Tariff C
30.00
Tariff D

20.00

10.00

.00
0.0 5.0 10.0 15.0 20.0 25.0
Data volum (X1)

PROBLEM
3. Jacob and Oliver are arguing about the value of sweet versus salty snacks. Oliver would prefer one bag
of salt pretzels and three bars of chocolate per week (point O1=(1, 3)) over a combination of two bags of
pretzels and two chocolate bars (point O2=(2, 2)). Jacob, however, is indifferent between having two
bags of pretzels with two chocolate bars (O2=J2=(2, 2)) and a combination of four chocolate bars with
just one bag of pretzels (J1=(1, 4)) or even one chocolate bar if he gets 4 bags of pretzels with it

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(J3=(4,1)). (Since we are discussing average weekly consumption pretzel bags and chocolates can be in
fractions.)

a. Sketch the preferences of Jacob and of Oliver with indifference curves in Figure 4.7.

b. In your graph, the two indifference curves will necessarily intersect at two bags of pretzels and two
chocolates (2, 2). Is this a violation of the standard assumptions of the properties of indifference curves?

c. Assume both young men have a budget of €6 to spend on snacks per week in scenario 1 (denoted
with superscript 1). A bag of pretzels costs P11=€2/bag and a chocolate bar is priced at P21=€1/bar. Could
any of the two reach a household optimum at two bags of pretzels and two chocolates (2, 2)?

d. Show and explain Oliver’s optimum consumption choice in scenario 2 (denoted with superscript 2),
when the price of a chocolate bar is still at P21=P22=€1/bar but the pretzels cost P12=€1.5/bag now and
his budget for snacks is reduced to €4.50.

e. Assume the price of the chocolates is falling. Show that for Jacob the two snacks are substitutes. [You
can do this in the abstract, not oriented at any of the prices or budgets given above.]

SOLUTION
a) The two blue dots in the graph below indicate information about the preferences of Oliver. O1
needs to be on a higher indifference curve than O2 which is shown with the solid and the dashed
blue curves. The indifference between points J1, J2 and J3 is displayed in the solid green
indifference curve for Jacob. All indifference curves conform to the usual criteria with regards to
slope and convexity.

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 b) Since the green and the blue indifference curves represent two different people there is no
problem when they intersect. However, always make sure that the indifference curves of the
same colour do not cross.
c) With the prices and the budget given, the budget line should intersect the chocolate axis at 4.5
bars of chocolate, which is the result when you divide the total budget of €6 by the price of
€1/bar. Similarly, both consumers can afford a maximum of three bags of pretzels with that
budget. Connecting these two points on the axis results in the solid green budget line. Given the
preferences is impossible to have any of the indifference curves tangent (just touching in one
point) to the budget constraint at O2= J2.
d) Even though his budget is reduced to only €4.50 Oliver can still afford three bags of pretzels
since they have become cheaper. However, with the new budget he can only by 4.5 bars of
chocolate at the most. To find Oliver’s household optimum one needs to find the highest valid
indifference curve, that is just touching this new budget constraint. This point would be the
maximum of utility attainable given the budget and the prices. Here the dashed indifference
curve is drawn in a way that puts the household optimum in O1. This point however could be a
little bit further up along the budget line and also a little bit further down, as long as the new
indifference curve does not intersect the solid blue indifference curve.
e) To show this effect, you can start out with a budget line that you already know, like the budget
from scenario 1. You could for example find a household optimum for Jacob with a dashed
green indifference curve that is consistent with the preferences shown in the solid green line.
Let us assume this is a situation where he consumes 1 ½ bags of pretzels and three chocolate
bars. Now, remember the definition of substitutes: if you reduce the price of chocolate bars,
Jacob’s consumption of pretzels should fall. To show this situation, you need to draw an
indifference curve that is consistent with the other two indifference curves but is also touching
the new budget line at a high number of chocolate bars and a smaller number of pretzel bags
than the old household optimum. This is given with the indifference curve at the point J4 with an
optimal consumption bundle of roughly 1.2 bags of pretzels and 4.5 bars of chocolate.

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 7,0
number of chocolate bars

6,5 Budget Scenario 3

6,0 Budget Scenario 2

5,5
Budget Scenario 1
5,0 J4

4,5
J1

4,0

3,5
O1
3,0

2,5

2,0

1,5 J3
O2=J2
1,0

0,5

0,0
0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 4,0 4,5 5,0
bags of pretzels

PROBLEM
4. Assume that the utility of a household only depends on the consumption of goods X and Y. The utility
function is given by TU=U(Y,X)=X_^(3/4) Y_^(1/4). Calculate the marginal rate of substitution.

SOLUTION
3 1
Take the first partial derivatives of the utility function 𝑈𝑈(𝑌𝑌, 𝑋𝑋) = 𝑋𝑋 𝑌𝑌 with respect to both 4 4

consumption quantities:
3 1 1 3
3 3 3 3 3 3
𝜕𝜕𝜕𝜕(𝑌𝑌,𝑋𝑋) 𝜕𝜕𝑋𝑋 4 𝑌𝑌 4 𝜕𝜕𝑌𝑌 4 1 −4 1 −4 4 1 𝑋𝑋
4
1 𝑋𝑋 4
𝑀𝑀𝑀𝑀𝑌𝑌 = = = 𝑋𝑋 4
= 𝑋𝑋 ×
4
𝑌𝑌 = 𝑌𝑌 𝑋𝑋 = = � � and
𝜕𝜕𝜕𝜕 𝜕𝜕𝜕𝜕 𝜕𝜕𝜕𝜕 4 4 4 34 4 𝑌𝑌
𝑌𝑌
3 1 3 1
1 1 1 1 1 1
𝜕𝜕𝜕𝜕(𝑌𝑌,𝑋𝑋) 𝜕𝜕𝑋𝑋 4 𝑌𝑌 4 𝜕𝜕𝑋𝑋 4 3 −4 3 4 −4 3 𝑌𝑌
4
3 𝑌𝑌 4
𝑀𝑀𝑀𝑀𝑋𝑋 =
𝜕𝜕𝜕𝜕
= 𝜕𝜕𝜕𝜕
= 𝑌𝑌 4
𝜕𝜕𝜕𝜕
= 𝑌𝑌 ×
4
𝑋𝑋 = 𝑌𝑌 𝑋𝑋 = 1 = � �.
4 4 4 4 4 𝑋𝑋
𝑋𝑋
Calculate the marginal rate of substitution requires dividing the two first derivatives:

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 3
4
1 𝑋𝑋
𝜕𝜕𝜕𝜕(𝑌𝑌, 𝑋𝑋) 4 3 3 1 3 1
+
4 4 4 4
𝑀𝑀𝑀𝑀𝑌𝑌 𝜕𝜕𝜕𝜕 𝑌𝑌 4 1 4 𝑋𝑋 𝑋𝑋 1 𝑋𝑋 1 𝑋𝑋
= = 1 = 3 1 = 3 1 =
𝑀𝑀𝑀𝑀𝑋𝑋 𝜕𝜕𝜕𝜕(𝑌𝑌, 𝑋𝑋) 4
4 3 4 4 3 4+4 3 𝑌𝑌
𝜕𝜕𝜕𝜕 3 𝑌𝑌 𝑌𝑌 𝑌𝑌 𝑌𝑌
4 1
𝑋𝑋 4

PROBLEM
5. Assume the utility function is still TU=U(Y,X)=X_^(3/4) Y_^(1/4). Plugging in some numbers will give
you for example U(0.05,8000)=〖8,000〗_^(3/4) 〖0.05〗_^(1/4)=400 and U(0.4,4000)=〖4,000〗
_^(3/4) 〖0.4〗_^(1/4)=400. So, these points represent the same level of utility and therefore, they are
on the same indifference curve. Since U(0.1,16,000)=〖16,000〗_^(3/4) 〖0.1〗_^(1/4)=800, the
combination of 0.1 units of Y and 16,000 units of X represents a higher utility of 800. Please show, using
examples like the above, that the “Four Properties of Indifference Curves” defined in Mankiw/Taylor
hold for the utility function given. (You may also use some of the results from the previous problem.)

SOLUTION
Indifference curves further to the right represent a higher level of utility: imagine a graph with X on the
horizontal axis and Y on the vertical axis. Start out with the point on the indifference curve representing
3 1
a utility of 400 𝑈𝑈(0.05, 8000) = 80004 0.054 = 400. Moving to the right would mean increasing the
3 1
value for X while maintaining the same level of Y. Use as an example 𝑈𝑈(0.05, 9000) = 90004 0.054 =
436.34. So, whenever you increase the value for X or Y while keeping the other value the same utility
will increase.

Indifference curves do not cross: this is apparent from the function itself. For any combination of X and
Y you get in the unique value for the utility U. So how should it be possible to have the same
combination of X and Y representing two different values of utility?

Indifference curves are downward sloping: you could start out with the examples
3 1 3 1
𝑈𝑈(0.05, 8000) = 8000 0.05 = 400 and 𝑈𝑈(0.4, 4000) = 4000 0.4 = 400. This already shows,
4 4 4 4

that when you increase the value of X from 0.05 to 0.4 you have to reduce Y from 8000 to 4000 to
maintain the level of utility at 400. So, the slope of an indifference curve at utility level of 400 has to be
negative because its positive change of the quantity X (dX=0.4-0.05) is associated with a negative change
of Y (dY=4000-8000=-4000). You can also do this more generally by showing:
3 1 1 3
400 − 400
𝑈𝑈(𝑌𝑌, 𝑋𝑋) = 𝑋𝑋 𝑌𝑌 = 400 ⇔ 𝑌𝑌 =
4 4 4
3 = 400𝑋𝑋 4
. Applying the power rules you can rewrite 𝑌𝑌 = 3 =
𝑋𝑋 4 𝑋𝑋 4
4 34
−
4001 𝑋𝑋 41
= 4004 𝑋𝑋 −3. This is the formula for an indifference curve in the X – Y graph at the level of
𝑑𝑑𝑑𝑑
utility of 400. If you now take the first derivative of this function 𝑌𝑌 = 4004 𝑋𝑋 −3 you will get =
𝑑𝑑𝑑𝑑
−3×4004
−3 × 4004 𝑋𝑋 −2 = 𝑋𝑋 2
, which is a negative number for all positive values of X.
Indifference curves are bowed inward: this property is given if for a fixed utility the slope of the
indifference curve is steeper when you have a small value of X compared to the slope for larger value of

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X. Fortunately we have already calculated the general formula for the slope of an indifference curve,
because it is the inverse negative value of the marginal rate of substitution from the last problem:
𝜕𝜕𝜕𝜕(𝑌𝑌, 𝑋𝑋)
𝑀𝑀𝑀𝑀𝑌𝑌 𝜕𝜕𝜕𝜕 1 𝑋𝑋 𝜕𝜕𝜕𝜕 𝑌𝑌
= = ⇔ =3
𝑀𝑀𝑀𝑀𝑋𝑋 𝜕𝜕𝜕𝜕(𝑌𝑌, 𝑋𝑋) 3 𝑌𝑌 𝜕𝜕𝜕𝜕 𝑋𝑋
𝜕𝜕𝜕𝜕
Since along a given indifference curve a smaller X is always associated with a larger Y, you can
immediately see from the above formula that the ratio of Y to X will be larger or smaller X gets. You can
𝑑𝑑𝑑𝑑 −3×4004
also see the result from = −3 × 4004 𝑋𝑋 −2 = 𝑋𝑋 2
where also a larger value of X will increase the
𝑑𝑑𝑑𝑑
expression for the slope in absolute value.

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