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Econ 2000 - Assignment 1

Show all working!

1. Sketch the indifference curve map that illustrates the ideas given below. Carefully
consider which goods go on each axis and be sure to indicate the direction of increasing
utility. In each case explain your reasoning.

a. Margarine is just as good as high priced spread.
b. Things go better with coke.
c. A day without wine is like a day without sunshine.
d. Popcorn is addictive the more you eat, the more you want.
e. It takes two to tango.

2.
a. A consumers demand curve for good x is = 1u - 2P. The price elasticity of
demand for good x at price P
-
is -
2
3
. Calculate P
-
.

b. The inverse demand curve of consumer 1 for good x is given as P = S -
1
2
. The
inverse demand curve of consumer 2 for the same good is given as P = 1u -2.
i. Determine the demand schedules for Consumer 1 and Consumer 2.
ii. Assuming that the two consumers are the only ones buying the good, derive and
graph the market demand for good x. (Consider only integer values).

c. Complete the following table. Be sure to show your working.

U(x
1
, x
2
) MU
1
(x
1
, x
2
) MU
2
(x
1
, x
2
) MRS(x
1
, x
2
)
2x
1
+ Sx
2


ax
1
+ bx
2


x
1
x
2


x
1
a
x
2
b

(x
1
+ a)(x
2
+ b)

x
1
a
+ x
2
b




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3. Charlie's utility function is u(x

1
, x
x
) = x
1
x
2
. Suppose that the price of apples is 1, the
price of bananas is 2, and Charlie's income is 40.
a. Derive an equation for Charlies budget line. On a graph with apples on the
horizontal axis, draw and label Charlie's budget line. (use 1 cm = 5 units and a
maximum of 40 units on each axis).
b. On the same graph, plot the indifference curve that gives Charlie a utility of 150 in
red ink. Plot the indifference curve that gives Charlie a utility of 300 in black ink or
pencil.
c. Can Charlie afford any bundles that give him a utility of 150? Why or why not?
d. Can Charlie afford any bundles that give him a utility of 300? Why or why not?
e. On your graph, mark a point that Charlie can afford and that gives him a higher
utility than 150. Label that point A.
f. Neither of the indifference curves that you drew is tangent to Charlie's budget
line. Let's try to find one that is. At any point, (x
1
, x
x
), Charlie's marginal rate of
substitution is a function of x
1
and x
2
. In fact, if you calculate the ratio of marginal
utilities for Charlie's utility function, you will find that Charlie's marginal rate of
substitution is HRS(x
1
, x
x
) = -
x
1
x
2
. This is the slope of his indifference curve at
(x
1
, x
x
). What is the slope of Charlie's budget line?
g. Write an equation that implies that the budget line is tangent to an indifference
curve at(x
1
, x
x
). Plot the line that passes through the points represented by this
equation.
h. The best bundle that Charlie can afford must lie somewhere on the line you just
drew in. It must also lie on his budget line. If the point is outside of his budget line,
he can't afford it. If the point lies inside of his budget line, he can afford to do
better by buying more of both goods. On your graph, label this best affordable
bundle with an E. Verify your answer by solving the two simultaneous equations
given by his budget equation and the tangency condition.
i. What is Charlie's utility if he consumes the bundle (20,10)?

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4. A consumer has the utility function u(x
1
x
2
) = x
1
12
x
2
12
. The price of good 1 is $40 per
unit and the price of good 2 is $10 per unit.
a. Derive an expression for this consumers budget line when her income is $400 and
another budget line when her income is $200. What is the slope of each budget
line?
b. The consumer wants to maximise her utility. Derive the demand functions for good
1 and good 2.
c. The optimal utility function is u
-
= u(x
1
-
x
2
-
). Solve for u
-
.


October 2011