Running Head: ASSIGNMENT 2 ECON20002 1

Assignment 2 ECON20002

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 ASSIGNMENT 2 ECON20002 2

Chun’s preference for goods g, petrol in litres per year and good y in units per year is U (g, y) = g0.02 y 0.78

a) Chun’s demand functions for petrol and good y

When marginal utility price ratios for the two goods are equal, this is where Chun’s level of utility gets

maximized.

Computation in the budget constraint

0.02 Of g= 0.78 of y

So 1 unit of g = 39 units of good y

M= marginal utility

p gg + p y y = m

p gg + 39 p gg = m

m
The demand for petrol is = g¿ ( p y , m) =
40 pg

p y y is equal to 39 p gg

p y y = 39 p gg × m/ 40 p g

p y y = 39m/ 40

The demand function of good y is therefore, y ( p y , m) = 39M/ 40 p y

b) Petro is directly related to Chun’s income and this makes petrol a normal good for him.

m
g¿ ( p y , m) =
40 pg
 ASSIGNMENT 2 ECON20002 3

∂g 1
= >0
∂ m 40 pg

c) Given the demand function for petrol, the function is not dependent on the price of product y and

therefore, petrol cannot be a complement or a substitute for good y.

d) If the price of petrol is $ 0.20 per liter while the price of y is $ 1 per unit, the income is $ 30,240. In

that year Chun will have consumed

p y = $ 1, p g= $ 0.20, marginal utility m= $ 30,240

m
g¿= is equal to 30,240/ 40 × 0.20
40 pg

g¿= $ 3,780

y ¿= 39M/ 40 p y which is equal to 39 ×30,240/ 40 ×1

y ¿= $ 29,484

e) When the price of petrol goes up from $ 0.20 to $ 0.60

The new price is p g 1= $ 0.60

m
g1= 40 p is equal to 30,240/ 40 × 0.60
g

g1= $ 1,260

As the price go up we have the consumer surplus going down.

 ASSIGNMENT 2 ECON20002 4

The change in consumer surplus is computed by

1/2 × (1,260 +3,780) × (0.60 - 0.20) = 0.5 × 5,040 × 0.4

= 1,008

price of petrol

0.6

0.2

Quantity of ptr

1,260 3,780

The part that is shaded shows the consumer surplus

f) Rebate plan by government of $ m

The new price of petrol by Chun is (0.2 -m)

m
Computing the new price g0.2−m =
40 pg 0.2 −m

30,240/ 40 × (0.20-m) = 756/ (0.2-m)

The new price that Chun will consume is

 ASSIGNMENT 2 ECON20002 5

h) Price Effect (PE) = Substitution Effect (SE) add Income Effect (IE)

Income effect describes a change in the level of demand given the change in real income that brings about
a change in the price of a product.

Price effect is the total summation of substitution effect and income effect

Substitution effect is where a change in prices of goods that can be used in place of the other or substitute
products has on the quantity demanded. Slutsky said that at the new price, fewer incomes are required to
purchase the original bundle and so the real income has risen. He said that when there is much income is
required to purchase original bundles and so the real income is reduced. An increase in price makes the
quantity bought reduces from 3,780 to 1,260 a reduction of 2,520

According to Hicksian, we reduce the consumer’s income so that we can remove the income effect. The
quantity demanded reduced from 3,780 to 1,260 which is substitution effect of 2, 520

2) The demand function of x is given by 𝑥 = 𝐴𝑝𝛼𝑝𝛽𝑀𝛾

The price of good x is Px and that of y is Py, while income is M. The parameters are A, a, b, y

Parameter for A

For the prices of Px it is greater than 0 and that of Py is also greater than 0 still, income M is also greater
than 0

P x aP y b M y ¿ 0

In this case, x is the demand for x so x is greater than 0

So when x > 0 and P x aP y b M y ¿ 0 it means that A has to be positive quantity and so the inequality seen
above is sustained. Therefore, A> 0 and this means that it is the restriction for parameter A.

Looking at a, we can tell that x is a normal good and so when its price Px goes up, its demand declines as
shown below in the equation

dx /dPx < 0 or

a.A.P x a−1P y b M y < 0 and therefore the inequality remains that a< 0, and so Restriction on a is a< 0

in the case that y and x are complimentary goods, an increase in the price of y, Py results to a reduction in
the price of good x and vice versa. Therefore, dx/dPy < 0, or

b.A.P x aP y b−1 M y < 0. In the case of A> 0 and P x aP y b M y ¿ 0, the inequality remains when b< 0, so
Restriction on b is, b< 0

A look at income M, we know that x is a normal good and when the income increases, consumption of
good x increases proportionately. So dx/dM > or it can be written as

y.A.P x aP y b M y−1 ¿ 0
 ASSIGNMENT 2 ECON20002 6

We saw that A¿ 0 and P x aP y b M y−1 ¿ 0 and therefore the inequality remains when the income is positive
or y¿0.Therefore restriction on y is, y ¿ 0

3) Connie buys goods x and y that makes her spend half of her salary on each of them

a) Her demand function for good x is

x= M/Px ……………. That is when Px> Py

x = 0 ………………….that is when Px< Py

x = M/2 ……………….that is when Px = Py

b) Connie’s demand curve for good x, when the money income is M, and the price of y is Py. The
demand curve is ½ M at Px is equal to Py, 0 at Px< Py and when it is Px> Py, there is a downward slope.
Notably, this makes the curve to be discontinuous at points Px=0 and Px=Py, and Px< Py, it is illustrated
below.

Px

Px=Py Dx

X
 ASSIGNMENT 2 ECON20002 7

M/ Px

References

Davidson, P. (Ed.). (2011). Post Keynesian macroeconomic theory. Edward Elgar Publishing.

Barzilai, J. (2016). Slutsky’s Mathematical Economics (pp. 1-5). Scientific metrics working paper.