Consumer Economics
Problem Set 2
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1. Consider the following utility function 𝑈(𝑥1 , 𝑥2 ) = 2 𝑥12 +ln 𝑥2
a. Are these preferences convex?
b. Find the Marshallian demand at 𝑝1 = 2 , 𝑝2 = 1.
𝑦2
2. Let 𝑈(𝑥, 𝑦) = (𝑥 + 2𝑦 − ) for x ≥ 0 and y ≥ 0. Let 𝑤 ≥ 0 be the wealth the consumer
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has available to spend on x and y. Let 𝑝𝑥 ≥ 0 𝑎𝑛𝑑 𝑝𝑦 ≥ 0 be the competitive prices for x
𝑤 𝑝𝑦 𝑤
and y. For case (a), assume ≥ 0 𝑎𝑛𝑑 + > 2.
𝑝𝑥 𝑝𝑥 𝑝𝑦
a. Derive the consumer’s Walrasian demands
b. Derive the consumer’s indirect utility function
c. Verify that the indirect utility is:
Homogeneous of degree 0 in p and w.
Strictly increasing in w and non-increasing in p
Quasiconvex in p.
3. One way to compare budget sets is by using the indirect preferences that involve
comparing 𝑥(𝑝, 𝑤) 𝑎𝑛𝑑 𝑥(𝑝′ 𝑤). There are two other approaches to making such
comparison: CV and EV. Solve the following exercises regarding a consumer in a two-
commodity world with a utility function U.
a. For the case of preferences represented by 𝑈(𝑥1 , 𝑥2 ) = 𝑥1 + 𝑥2 , calculate the two
consumer surplus measures ( i.e CV and EV)
b. Show that the good 1 is a normal good. What is the relation of the two measures to
the “area below the demand function” (this is the standard definition of consumer
surplus?
c. Explain why the two measures are identical if the individual has quasilinear
preferences in the second commodity and in a domain where the two commodities
are consumed in positive quantities.
4. Mariam’s preference over three goods are given by:
𝑈(𝑥1 , 𝑥2 , 𝑥3 ) = 𝑥1 + 𝑚𝑖𝑛{𝑥2 , 𝑥3 }
a. Find her Marshallian demand for good 2.
b. If Mariam’s wealth is W = 10. Determine the substitution and income effects on
her consumption of good 2 if prices change from (𝑝1 , 𝑝2 , 𝑝3 ) = (.25,.25,1) to
(𝑝1 , 𝑝2 , 𝑝3 ) = (.2,.8,1.1)