Problem Set 1

Question 1(a) budget constraint :

169 + 2492 = 240 , budget line has intercept which hoshostal twetanstheresume good I all and on vertical means consume
good I all .
92
horizontal axis intercept Y -

consume good 1 only : 92 = 0 , 1691 =

240 , 91 =
15
100

vertical axis intercept : -

good only 91 2492 240 , 92 10

=
consume
=
2
: = 0,
11

;59 ,

slope of the
budget constraint :
k =
-

* =
- =
-

5
, 92 =
-

591 + 10

horizontal axis intercepti

CD) Based on the
price discount ,
the first 6 units cost 16 dollars : 6x16 =
96 ,
(240-96) + 12 =
1 units
,
6 + 12 = 18 units ,
so when consumers

consume all
money on
good 1 ,
they will have 18 units.

vertical axis intercept :

Because the will be the same

the
price of good 2 does not
change , which means intercept as (a) , so qu
=
10

=
2
92x - =
5 (9 , 56) 92 591 + 10

I-
The slope of budget is =
-

Lg
,

10 = =
-

[ (916) 92 = -29 +9

·
,

The @ line will be flatter than the O line ,

there exists a kink. .

(C) The slope of the line will be the same as the (b).

when 9156 , P1 =
16 , 1691 + 2492 240909 = =
-

594

when 916 ,
P1 =
12
,
129 ,+ 2492 240 =
, so 92 = -E91410

. 6

(d) 92 remains unchanged because there has no roucher on

good 242 /
=
10

9, in roucher :
192 = 16 =
12 units ,
the slope of the line after roucher expires will be - - = =
-5

92x
9) :
12 + 15 =
27 units

·
The 0 horizontal line shows his her the
money after
that the consumer doesn't pay or ,

roucher will which shows about the @ line.

expires consumer use own
money ,
 Prove :

Question 2 Demands must lie within the budget set :

p'fcp , m) = m

Adding Up = In most cases the budget will be exhausted

by consumer ,
so p'fcpimi = m

:P
Differentiating with
respect to m

=9 dak x
=
10

budget share of goods K : WK =***

income
elasticity
: EK =
and ③
put @ into 0 : WKEK 1 which the basic
property of demand called adding
=
is
up
,
.

According to the adding up ,

we can know that it shows the weighted average about the income effect of all goods are
equal to one ,
which also means that not all
goods

can be inferior good (ERCO) , luxuries ([R>1) ,

necessities ([RE(0 1)) . 1

So these two goods cannot both be inferior.

Question 3 Pj9j =
xj +
Bjm +jkPk for j = 1, . . .
,
]

(i)
adding up adding up
rule based on p'fcp,m) =
m , so Pjaj =
m
is
necessary

P9= MNP + =
m

o &
,
it satisf the adding
a

ciishomogeneity Homogeneity shows fcxp , xm) =

fcpm) for any RO ,
so
9j(p , Xm) =

9jcp m) is necessary
,

9j(p , my =+
9j(p Xm) ,
=
9) xp . Xm) =
9j(pim) when for any No ,
which means dy must be zero

so dj = 0 ,
it will satisfy homogeneity
.

Question 4 Indifference preference relation ~ shows that consumers think goods are all
good.

For if which ALB and BIA

example , A-B ,
it means A is
equally good as B ,
equivalent to

If indifference preference is transitive ,

we need to
prove ArB and BrC ,
then Arc
We know that
and
~ is
complete transitive .
If ALB ,
it means A is at least as
good as B

complete :
for any A & B either ALB on B2A or both
&
, ,

transitive : for any A &B & C , if ALB and BJC then AS

Prove :
ArB if both ALB and BLA

DrC if both B2C and CIB

ALBandBLC ,
CiBandBirA , so AnC, ChA
So ArC , indifference preference relation is transitive
Question 5 P **
"
=
P ,P , /Pi Pz) .
=
(ECP P) +P +
,

So Pip" =
Based on the hint , for two
positive variables VIFV2 ,>Mist ,
Vita

P,
9
+ P,
b
,
PcFib

SoletV =
P,
9
,
V =
P , Us =
129 , Vy =
P
P, pop ==B =
P , P P, OBSO
= PAR > P,
Y

Max U(XX) subject to Pix + PA =

M Pip > pop
Lagrangian : ((X1 , X2 , x) =
X , Xz + x(m-P , X, -

P2X)

* =
X2 -

N =0 x = so X2 =x
1 ** =
x1 - 2
=
0 x =
*
=X 0
put O into &
PIX + REFm = X =
SP
X , ,
so , ,

, XI + 12Xc Me =

So the maximum
utility x = =
Upp , ms = this function is
monotonically decreasing with p increase

P,
"
P, Sp which have
Milwaukee Madison means that they same indirect
utility
: = :
,

Chicago :
Pip" > P,P ,
Pip > p& Vc =< Va =
Ub because PRR P P2= Pipe ,

If he she will Miwankee Madison .

the retiree is a
utility-maximize , or choose or
Question 6 u(X) =

A, A =
(1) -
Marshallian demand function :

budget constraint :
Lagrangian :

* XiPi
i =
1
=
m (income) ↓ A Xm-P +

Take the first order condition to maximize

UCX) :

= AXXR-NP other X =
are constant factors and will be kepta

AXiXIX21
MXR XP =

UX) =
A AXTR = So
A
↓ Xi, = Mi ,
we need to eliminate UCX) and X ,
FOC =
Li =
Xi

& it shows that the ratio of goods that consumers choose are
only depend on didn and

aa
# qPm
PiXI
which does not related function .
theutility
ratio to
=

, and

- · q M
=

= miXi M =

(2) Indirect
utility function :

V(p , m) =
Aid =
Ad Am =

13) expenditure function : This function is the minimum amount

of money to reach the
utility
U(X Aim Am =
=

= e(p , = )

=
(4)hichidemdm
epu g
=
,

Li

↓
Question 7 Ucq1 , 92) =
min1391-1 92-33 ,
,
when 391-1 =
92-3 i n e .

q =
391 +
92 391 +2

Mica
=

(a) We will have the L shape along point A B ,

Uz
live the
The indifference curves are bunch of L shapes Sitting on a
running through origin with
equation 92 391th
=

UI

(b) (i) strongly monotonic respectly

monotonicity : it has three situations which are
weakly monotonic , monotone and

The consumer's preferences satisfy the

weakly monotonicity ,
not the
strong monotonicity
U (91 , 92) =
min 5391-1 92-3) ,

I as increases , 391-1 will increase , min939-1 92-3) ,

will not decrease

If 92 increases ,
92-3 will increase , min
$391-1 9rs] ,
will not decrease , either .
So it
satisfy the
monotonicity

But depend will

may depend 923391th
9 , 0092 if utility 391-1 391-192-3 if 92
in this
utility function ,
it on , so is on ,
when ,
i e
. .

,
increase ,
it not

change the minimum , so it does not

satisfy the
strong monotonicity
,

shows that if whenever go -9 , for Xec, 1) it has two situations that N90 + CHX9290 weakly
(ii)
convexity preferences are
:
convexity , convex,

Xqo + c+ N)9's go ·
preferences are
strictly convex .

This
preference satisfy convexity but not the strictly convex

92 391 +2
=

graphs 9 and 9 has the same utility 9"is if 93 > 90 91 , it will show the
according midpoint strong
to the ,
the , ,
,

Ul
· but this situation 90 and 9 which violates the but suitfor weaR
I
convex , in , the
midpoint is as good as the , strict convex
,
graph 1 convex
because flat straight line
,

it has a

[O] U19 92) ,

=
min 9391 +

1 , 92-35 ,
391-1 =
92 - 3 ,
92 =
391 +20 segment

E budget constraint :
P191 + 1292 = m @

put ① into e : P191 + P2239 , +2) =

M ,
so 9 = M

(a) 9 = 92 =
V min(39
=
, 92-3) =
minim
Roy's identity :
a consumer's Marshallian demand function for good R can be derived from an indirect
utility function by

i The solution of 91 and

identity valid.
92 are equal to the (2)
, which shows that the Roy's

=
is

(e) u(9192) min =

3391-1 , 92-4) , 3911 =

92 4 -

, 92 =
391730

budget constraint : P191 + 129 =

me

put O into & :

P , 9 + P2191 +3) = M
91 ,
92 =
391 =
P191 + 39291 + 3Pz = m
The
Marshallian demands the and have
second consumer does not have the same as
original consumer ,
the optimal quantity changes they
different indifference kink .
 ** MD , HD

application # optimal choice

def :
EAEFE

Problem Set 1 164Ny

E THE AGE (a)

92b)
x

grl ,

- ·
&

10
Due on September 24, 5pm
#
16.
.

·
120,07
91
Question 1
m =
240
Consider a consumer with income of $240 [who chooses between two goods, 1 and 2. In each of the
following cases, O
vertical intercepts:
-
-

&
graph the consumer’s budget constraint and include the values of the horizontal and
intercept

O per unit and the price of good 0

(a) When the price of good 1 is $16 O per
.
2 is $24 .. 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

x1 and O
Prove: If a consumer consumes only two goods, say 0 x2 , then these two goods cannot both be -

inferior. rule > Not all

adding up be

goall
can
-

[10 points]

Question 3

~
You wish to model the demands of a consumer with total budget m who, for J goods q, faces prices
O
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 q j = ↵ j + jm + k jk pk for j = 1, . . . , J

[10 points] xj + jm + URPR

#9
=

1
 ALB- > A is at least as
good as B

ArD Bic, -And

Question 4
CIB, BLA CIA >
-

Suppose the preference relationO

indi↵erence preference relation ⇠ is transitive. [10 points]
* B
I
% is complete and transitive. Use this to establish whether or not the -

-
Bac - Anc ,

Question 5

Consider a retiree with a fixed income m who wishes to choose a city to live in among Milwaukee,
Madison, and Chicago. ISuppose their choice depends only on the utility function u = x1 x2 , where
(x1 , x2 ) 2 R2+ . IThe 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 = 1 a
2 (p1 + 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

> (iv)
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 x↵
i ,
i
A > 0, ↵i = 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

-

The price of good j 2 {1, 2} is pj and the consumer’s total budget is m.

1, q2 3} . bontie [
(a) Draw the consumer’s indi↵erence 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]

Indirect functive
utility
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]