CLARA MILLER
Principles of Economics Professor Pete Ferderer
Problem Set #4 Fall 2021
Due: Monday, October 11 at 10:30 am (In my mailbox in 310 Carnegie)
1. The Beatles are consuming ice cream cones and movies. The following table shows the marginal
utility each member of the band derives from the last unit consumed of each good. Ice cream cones
cost $4 and movies $12.
Marginal utility of Marginal utility of
last ice cream cone last movie
John 24 96
Paul 12 36
George 20 36
Ringo 100 300
a) Which, if any, of these people is maximizing their utility? Explain.
a. Paul and Ringo have both maximized their utility because they place the same value in
utility on ice cream versus movies as the market does, meaning the market values movies
at three times the rate of ice cream, as do Paul and Ringo.
b) How must the others adjust their consumption between ice cream cones and movies to maximize
their utility? Explain.
a. John should move towards less ice cream and more movies to maximize his utility, and
George should consume more ice cream to maximize his utility.
2. For Jack, cheese cubes and crackers are perfect complements: he wants to consume exactly one cheese
cube with each cracker. He has exactly $2.40 to spend on cheese cubes and crackers. One cheese cube
costs 20 cents, and one cracker costs 10 cents. Draw a diagram, with crackers on the horizontal axis
and cheese cubes on the vertical axis, to answer the following questions.
a) Which bundle will Jack consume? Mark this with the letter A on the budget constraint and
indifference curve.
b) The price of crackers rises to 20 cents. How many cheese cubes and how many crackers will Jack
consume? Mark this with the letter B on the new budget constraint and the indifference curve.
c) Show the income and substitution effect from this price rise.
3. For Jane, gasoline from ExxonMobil and gasoline from British Petroleum are perfect substitutes. She
has exactly $30 to spend on gasoline. ExxonMobil gasoline costs $2.00/gallon, and British Petroleum
gasoline costs $2.50/gallon. Draw a diagram, with Exxon gasoline on the horizontal axis and British
Petroleum gasoline on the vertical axis, to answer the following questions.
a) Which bundle of ExxonMobil and British Petroleum gasoline will Jane consume? Mark this with
the letter A on the budget constraint and the indifference curve.
b) The price of ExxonMobil gasoline rises to $3.00/gallon. Which bundle of ExxonMobil and British
Petroleum gasoline will Jane consume? Mark this with the letter B on the new budget constraint
and indifference curve.
c) Show the income and substitution effect from this price rise.
4. Chris is a lawyer and is awake for 100 hours per week. She spends some of this time enjoying leisure
(jogging, watching TV, hanging with friends, etc.) and spends the rest of her time doing legal work. For
every hour she works, she earns $50, which she spends on consumption goods (food, clothing, rent,
etc.). Her wage ($50) reflects the trade-off Chris faces between leisure and consumption.
a) In the following diagram, illustrate Chris’s budget constraint. What is the maximum amount
consumption she can purchase if she has no leisure time? What is the maximum amount of leisure
she can engage in if she does not work and, thus, does not purchase any consumption goods?
a. Chris can consume $5,000 of goods if she only works and does not take any leisure time.
Conversely, if she chooses not to work, she can spend 100 hours a week enjoying leisure.
b) What level of leisure and consumption maximizes Chris’ utility if her preferences are given by the
indifference curves shown in the graph? Explain.
a. To maximize Chris’s utility, she should engage in 60 hours of leisure and $2,000 of
consumption as this is where the budget constraint and indifference curves are tangent to
each other.
c) Suppose Chris can earn $100 per hour. Show how the budget constraint changes. What is the new
level of leisure and consumption that maximizes Chris’ utility? Explain.
a. The new levels that maximize Chris’s utility are about $5,500 of consumption and about
45 hours of leisure. After adjusting the budget constraint curve to match Chris’s new
salary, this is the point at which her new constraint is tangent to a higher indifference
curve. This change is likely due to Chris placing more value on spending time working
(thanks to her higher salary), which allows her to spend more on goods but gives her less
time for leisure.