Problem Set 1
Due on September 24, 5pm
Question 1
Consider a consumer with income of $240 who chooses between two goods, 1 and 2. In each of the
following cases, graph the consumer’s budget constraint and include the values of the horizontal and
vertical intercepts:
(a) When the price of good 1 is $16 per unit and the price of good 2 is $24 per unit. [5 points]
(b) When the price of good 2 is $24 per unit, but good 1 has an incremental price discount: the
first 6 units cost $16 each and all additional units cost $12 each. [5 points]
(c) When the price of good 2 is $24 per unit, but there is an all-units bulk discount for good 1: the
price is $16 per unit if 6 units or fewer are purchased, and $12 per unit if more than 6 units are
purchased. [5 points]
(d) When the price of good 1 is $16 per unit and the price of good 2 is $24 per unit, but the
government gives the consumer a $192 voucher that can only be redeemed against good 1. [5
points]
Question 2
Prove: If a consumer consumes only two goods, say x1 and x2 , then these two goods cannot both be
inferior.
[10 points]
Question 3
You wish to model the demands of a consumer with total budget m who, for J goods q, faces prices
p. To do this you write down the following parametric demands. What restrictions are necessary on
the parameters of the demands for them to satisfy (i) adding up (ii) homogeneity?
P
pj qj = αj + βj m + k γjk pk for j = 1, . . . , J
[10 points]
1
Question 4
Suppose the preference relation % is complete and transitive. Use this to establish whether or not the
indifference preference relation ∼ is transitive. [10 points]
Question 5
Consider a retiree with a fixed income m who wishes to choose a city to live in among Milwaukee,
Madison, and Chicago. Suppose their choice depends only on the utility function u = x1 x2 , where
(x1 , x2 ) ∈ R2+ . The price vector in Milwaukee is pa1 , pa2 and in Madison is pb1 , pb2 , with pa1 pa2 = pb1 pb2
but pa1 6= pb1 and pa2 6= pb2 . The price vector in Chicago is the component-wise average of those of
Milwaukee and Madison:
pc1 , pc2 = 21 (pa1 + pb1 ), 1 a
2 (p2 + pb2 ) .
If the retiree is a utility-maximizer, which city will they choose?
[Hint: Remember the arithmetic mean of two positive variables v1 6= v2 , given by (v1 + v2 )/2, is larger
than the geometric mean, given by (v1 v2 )1/2 .]
[10 points]
Question 6
Consider n goods with a Cobb–Douglas utility function
n
Y n
X
u(x) = A xα
i ,
i
A > 0, αi = 1.
i=1 i=1
(1) Find the Marshallian (uncompensated) demand for each good. [5 points]
(2) Find the consumer’s indirect utility function. [5 points]
(3) Compute the consumer’s expenditure function. [5 points]
(4) Compute the Hicksian (compensated) demand for each good. [5 points]
Question 7
A consumer has preferences over two goods given by
U (q1 , q2 ) = min { 3q1 − 1, q2 − 3} .
The price of good j ∈ {1, 2} is pj and the consumer’s total budget is m.
(a) Draw the consumer’s indifference curves. [5 points]
(b) Do the consumer’s preferences satisfy (i) monotonicity (and if so, strong monotonicity?) (ii)
convexity (and if so, strong convexity)? [10 points]
(c) Solve for the consumer’s Marshallian demand functions. [10 points]
(d) With these preferences, verify Roy’s identity for both goods. [10 points]
2
(e) Suppose a second consumer has preferences
U 0 (q1 , q2 ) = min{ 3q1 − 1, q2 − 4 }.
Will they have the same Marshallian demands as the original consumer? Why or why not? [5
points]