MICROECONOMICS II

Resolution of Practical Exercises

Chapter 5

Teacher in Charge: Mag. Ana Elisa Giráldez

Adjunct Professor: Mag. Marcos Ochoa
Adjunct Professor: Mag. Maximiliano Albornoz

1
 UNIT 5

The problems in this chapter focus on the analysis of statics.

comparison of changes in income and prices. Most of the
problems are clearly simple therefore, students can
address the ideas involved in changes to the restrictions
budgetary in a simplified way. Theoretical issues are located
in the expansions, those that illustrate for the Cobb-Douglas case, the slogans
of Shephard and Roy's identity.

Exercise 5.1

Comentario:

An example of perfect substitutes.

Ed 'the thirsty' only drinks mineral water. He can buy it in two different containers:
0.75 liter bottles and two liter bottles. Since the water is, in itself, the same,
consider these two 'goods' as perfect substitutes.

a. Assuming that Ed's utility only depends on the quantity consumed of

water, and that the containers provide no utility in themselves. Show that this
utility function in terms of quantities of 0.75-liter bottles (X) and
2-liter bottles (Y).

Utility function for "perfect substitutes" goods

8
U ( X,Y )=amount of water=0.75X+2 Y = X + Y
3

b. Show the demand function of Ed for X as a function of Px, Py, and I.

Since the goods are 'perfect substitutes,' it doesn't matter whether you buy a ¾ bottle or a
2-liter bottle in the sense that they are the same goods. The difference is given by the
prices.

0.75PX =2 P Y

3
P=2 P
4 X Y

8
P X = PY
3

2
To obtain the demand for X, a segmentation is carried out according to the different levels of
precios:

{
I 8
P X≤ PY
PX 3
X=
8
0 P X > PY
3

c. Draw the demand curve for X, keeping I and Py constant.

d. How do changes in I and Py shift the demand curve for X?

The increase in income shifts the demand outward. If the price of Y decreases but
it is maintainedP<
8 8
X P
it does not affect the demand for X. now it doesP>
X P , then the demand
3 Y
3 Y
de X is equal to zero.

The variations of P Y it does not affect demand until it reverses inequality.

e. What shape would the compensated demand curve for X have in this situation?

The compensated demand curve for X is simply the pair ( X, P X ), which characterizes the
current consumption. Any change of P X debería cambiar la utilidad desde ese punto
(assuming ( X > 0).

The compensated demand curve consists of only two points (or vertical lines).

Exercise 5.2

Comentario:

3
An example of fixed proportions. It illustrates how goods are used in fixed proportions.
(peanut butter and jelly) can be treated as an individual good in static analysis.
comparison of utility maximization.

David N receives $3 a week to spend as he wishes. Since he only likes the

peanut butter and jelly sandwiches, spends all their rent on
peanut butter (at $0.05 per ounce) and jelly (at $0.10 per ounce). The bread is
receive free from a friendly neighbor. David has a big appetite and makes his sandwiches.
with exactly one ounce of jam and two ounces of butter. It is narrow-minded
and it never changes these proportions.

a. How much butter and jam will David buy with his $3 weekly?

Fixed proportions function: the relationship is 2J = PB

PB
U ( J,PB ) =min( J )
2

3=0.05PB+ 0.10J

J = Jam

PB= Manteca

3=0.05(2PB)+0.10J
300=5(2 J )+10J
300=10J+10J
300=20J
300
J ¿= =15 Jam
20
¿
PB=2 J =30 (Manteca)

b. Suppose the price of the jam increases to $0.15 per ounce. How much
Will you buy each item?

3=0.05PB+ 0.15J

3=0.05(2 J )+0.15J

300=5(2 J )+15J
300=10J+15J
300=25J
300
J ¿= =12(Jam)
25

¿
PB=2 J =24 Peanut butter
4
 The quantity of X falls by 3 units and that of Y by 6 units. The decrease of Y.
it falls exactly in the units of X multiplied by the proportion between them.

c. How much should David's pay be increased to compensate for the

increase in the price of jam in the previous section?

∆I=∆pJ∆ J + PB∆pPB
0.75=0.15∗3+ 0.05∗6

The units of jam (J) and peanut butter (PB) are considered that
decreased by 3 and 6 units respectively due to current prices. Which results in the
additional extra income.

d. Draw the results of the previous sections.

e. In what sense does this problem imply a single good: snacks of

butter and jam? Draw the demand curve for this single good?

5
David sólo usa PB + J para hacer los sandwichs (en proporciones fijas) y debido a que el
bread is free, it is treated as if David buys the sandwich where:

P sandwich= pJ+2pPB

P0sandwich=0.10+0.05∗2=0.20

P1sandwich=0.15+0.05∗2=0.25

I 3
P Sandwich( the part)=0.20 Q S= = =15
P S0.20
I 3
P Sandwich( part b)=0.25 Q=
S = =12
P S0.25

The graph, for the sake of practicality, is located in the previous item, at the bottom.

f. Analyze the results of this problem in terms of the income and effects.
substitutions involved in the demand for jam.

There is no substitution effect due to fixed proportions. A change in prices

It results only in an income effect.

Exercise 5.3

Comentario:

A simple graphic analysis. It could be used to focus on compulsive purchases or

rational (for example, air-bag).

Suppose that, by law, a person is required to consume a fixed amount of good X.

X
for example,0Assuming that good X is a normal good, explain how it reduces
this law is beneficial for both people with high incomes and people with low incomes
low.

6
Given thatU<U:
1 2

You can achieve higher profit if free choice is allowed (a similar situation occurs
if they are forced to buy less than they would like).

Exercise 5.4

Comment:

A simple problem for which a verbal solution should basically be enough.

This is a good question for an oral exam.

Prove that, if there are only two goods, X and Y, the two cannot
they are inferior at the same time. If X is inferior, how do the variations of the
rental on demand of Y?

I =XpX +Y pY

∆I=∆XpX+ ∆Y pY

If both goods are inferior:

∂X
<0
∂I

∂Y
<0
∂I

So there is rent left unspent.

7
If both goods are inferior, it means that in the face of an increase in income I
(keeping prices constant), individuals would choose a smaller amount both
of X and Y. But since it would leave some income unspent, this violates the hypothesis of
utility maximization.

Exercise 5.5

Comment:

An exploration of the notion of homothetic functions. It will show that the Giffen paradox
it cannot happen for homothetic functions.

As defined in chapter 3, an indifference map is homothetic if one

a straight line originating from the origin intersects all the indifference curves at points that
They have the same slope: the Marginal Rate of Substitution (MRS) depends on the ratio of Y/X.

∂X
a. Show that, in this case, it is constant.
∂I

A map of indifference curves is homothetic if it responds to increases in income with

constant prices of goods, the marginal rate of substitution does not change and depends on the
quotient X/Y. That is, it is a straight line that starts from the origin point and intersects all the
indifference curves at points that have the same slope.

For the case of the Cobb-Douglas function:

α 1−α
U ( X ,Y=X
) Y

Y
Your TMS is:
X

The demand functions are as follows:

αI
X ¿=
pX

(1−α )I
Y ¿=
pY

∂Xα
= =constant
∂ I px

∂Y (1−α )
= =constant
∂I pY

Meets the condition.

8
 b. Show that it is possible to represent an individual's preferences by means of
a homothetic indifference map, price and quantity must move in
opposite directions; that is to say, prove that the paradox cannot be produced.
of Giffen.

∂X −aI
=−aI PX−2 = <0
∂PX P2X

∂Y−βI
= <0
∂ P Y PY2

∂X
>0
∂I

∂Y
>0
∂PY

Therefore, the derivatives of the demand with respect to prices are negative and with
Regarding income, they are positive (no good is inferior). Therefore, the good is not
GIFFEN. Engel curves are straight lines.

Exercise 5.6

Comentario:

Utility maximization for a CES function with limited substitution.

Assume that the utility an individual derives from X and Y is represented by the
CES function( by δ=−1 ).

−1 1
Utility=U ( X , Y) = −
X Y

a. Use the Lagrange multiplier method to calculate the functions of

uncompensated demand of X and Y for this function?

CES function (withδ =−1 ¿

−1 1
U ( X,Y )= −
X Y

L=− X−1−Y −1+ λ(I −XpX −YpY)

∂L 1
= −p λ=0( I )
∂ X X2 X

9
∂L1
= − p λ=0 (II)
∂Y Y 2Y

∂L
=I − XpX −Y pY=0 (III)
∂λ
From (I) and (II) I obtain the relationship:

1 1
2
=λ y =λ
p XX pYY 2

√ √
pX pY
p yY 2= p xX 2→Y=X ;X=Y
pY pX

Replacing in (III)

√
pY
I −Y p−Y pY=0
pX X

I =Y √ p Y p+Y pY
√ pX X

[√ ]
pY
I =Y pX + pY
pX

I
Y ¿=

√
py
px +p
px y

In a similar way

I
X ¿=

√
px
py +p
py x

b. Demonstrate that the demand functions calculated in the previous section

they are homogeneous of degree zero in px, py, and I.

Marshallian demands are homogenous of degree zero if they satisfy:

X ( λp, λI )=X ( p , I )

λI λI I
Y ¿= = =

√ ( √ )(√ )
λp y py py
λpx +λpy λ px +p px +p
λ px px y px y

10
 λI λI I
X ¿= = =

√ ( √ )( √ )
λpx px p
λpy + λp x λpy +p p yx+ px
λpy py x py

Clearly, if income and prices increase in the same proportion, there is no

modifications in the demand.

c. How do changes in I or py shift the demand curve for good X?

I
X= 1
2
√px
p yp+ x

∂X 1
= >0
∂I

√
p
p yx+ p x
py
−1
−I∗p y 2 √ px
∂X 2
= 2 <0
∂py 1

( p p+√ p
y
2
x x )
Increases in income increase the demand for X. An increase in Py reduces the
demand for X.

Exercise 5.7

Comentario:

Ask the students to continue the analysis of example 5.1 to obtain functions of
compensated demands. Fundamentally, it replicates examples 5.3 and 5.4.

As in example 5.1, suppose that the utility is given by

0.3 0.7
Utility=U X( ,Y=X) Y

a. Use the uncompensated demand functions from example 5.1 to calculate

the indirect utility function and the expenditure function.
["0.3","0.7"]
U ( X ,Y=X
) Y

L= X 0.3Y 07 + λ(I − Xpx −Ypy)

∂L
=0.3X−0.7Y0.7− p xλ=0( I)
∂X

11
∂L
=0.7X0.3Y −0,3 − p yλ=0 (II)
∂Y

∂L
=I − Xpx −Ypy =0 ( III)
∂λ

By clearingλ from (I) and (II), we obtain:

0.3X−0.7Y 0.70.7X0,3 Y −0.3

=
px py

0.3X−0.7Y 0.7 p x
=
0.7X0.3Y −0.3 p y

3 Y px 7px
= →Y= X
7Xpy 3py

Replacing in (III):

7px
I −Xpx − Xpy
3py

7px 7
I =Xpx +
3
X→
I= X px+ p x
( 3 )
0.3I
X ¿=
px

0.7I
Y ¿=
py

Indirect utility function:

0.3 0.7
0.3I 0.7I
At( p, I)=U X,( Y=
¿ ¿
)
( )( )
px py
=[Link].7I px−0.3py−0.7

Where K=0.3 0.30.7 0.7

In ( p, I=AI
) px−0.3py−0.7

AI
V ( p,I
) =p 0 ,3 0 ,7
x p y

I transform V = U and then I = E

p x0 ,3p 0y,7 U
=I =E= Function of Spending
K
12
 b. Use the calculated expenditure function from the previous section along with the motto
de Shephard (footnote 5) to calculate the demand function
compensated for good X.

∂E 0.3U px−0.7p0y,7
=X ( U , px, py)=
∂px K

∂E 0.7U px0 ,3py−0.3

=Y(U , px , py )=
∂py K

They are the compensated claims.

c. Use the results from the previous section, along with the demand function
without compensating for good X, to demonstrate that the equation is fulfilled
Slutsky in this case.

Slutsky equation:

∂X(I , px,py) ∂X(U, px, py) ∂X

= − X
∂px ∂px ∂E

∂X( I , px, py ) −0.3I

=
∂px p2x

∂X(U , px , py ) (−0.7)0.3U px−1.7p 0y,7

=
∂px K

∂ X 0.3 ∂ X ∂ X
= → =
∂ I PX ∂ E ∂I

0.3I
X=
PX

∂X( I , px,py) ∂X(U , px , py ) ∂X

=¿ −¿ X
∂px ∂ px ∂I
−0.3I (−0.7 ) 0.3U px−1.7p 0y,7 0.3 0.3I
=¿ −¿
px2 K P XP X

13
 ∂X(I , px , py ) ∂X( U, px, py) ∂X
=¿ −¿ X
∂px ∂px ∂I
−0.3I (−0.7 ) 0,3KI px− 0.3py−0.7px−1.7p0y,7 0.3 0.3I
=¿ −¿
2
px K P XP X

−0.3I−0.21I0.09I
= −
px2 P2X P2X

It meets the Slutsky condition.

An alternative change would be through 'elasticities':

e XPx =e X,PX −s Xe X, I

e X,Px =−1 ¿

e XPX=−0.7(compensated claim)

−1=−0.7−0.3∗1

Exercise 5.8

Comentario:

Another example of utility maximization. In this case, the utility is not separable and the
cross-price effect is important.

Assume that the utility function of X and Y is given by:

Utility=U ( XY
, =XY+Y
)

a. Calculate the uncompensated (Marshallian) demand functions for X and Y.

describe how the demand curves for X and Y shift when income (I) changes
price of the other asset.

U ( X,Y)=XY+Y

L= XY+Y + λ( I −Xpx −Ypy )

∂L
=Y − p xλ=0 ( I )
∂X

∂L
=X +1− p yλ=0(II)
∂Y

∂L
=I − Xpx −Ypy =0 ( III)
∂λ

14
Clearing λ
from (I) and (II), we obtain:

YX+1
=
px py

( X +1) p x
Y=
py

Replacing in (III):

(X +1) p x
I −Xpx − py
py

I =Xpx + ( X +1) p x

I =Xpx + Xpx + p x

I =2X px+ p x

I − px
X ¿=
2px

Y py Y py I − px
−1=X → −1=
px px 2px

Ypy −p xI−p x
I − px
= ⟶ Yp y − px =
px 2px 2

2 Yp y −2px =I − p x 2Y p y =I+ p x

I+ p x
Y ¿=
2py

Variations:

∂ X −I1
= 2 − <0
∂px 2p x 2

∂X 1
= >0
∂ I 2px

I px
Y ¿= +
2py2py

∂Y 1
= >0
∂I2py

15
∂Y 1
= >0
∂px2py

∂X
=0
∂py

Changes in py do not affect X, but changes in px affect Y.

b. Calculate the expenditure function of X and Y.

First, I obtain the indirect utility function:

V ( p,I )=
( I − p x) (I + p x) I+ p x
+
2px 2py 2py

(I 2 +Ipx −Ipx −p 2x) I + p x

V ( p,I )= +
2px2py 2py

(I 2− p2x ) I+ p x
V ( p,I )= +
4pxp y2py

( I¿¿2− p2x )+4pxp y(I + p x )

V ( p,I )=2py ¿
8pxp 2y

V ( p,I)=2pyI 2−2pyp x2 +4px p yI + 4pypx2¿ ¿

8pxp2y

2pyI 2+2pyp x2 +4pxp yI2I2+2p2x + 4pxII2+ p x2 +2pxI

V ( p,I )= = =
8px p 2y 8pxp y 4px p y

In ( p, I=
( I + pX )
)
4pxp y

I obtain the expenditure function, E:

2
U4p p=
x Iy+ p
( X )

√ U4p p=I+
x y p X

√ p−xp
I = U4p y X

√ p−x p y
E= U4p X

16
 c. Use the expenditure function calculated in the previous section to calculate the
compensated demand functions of X and Y. describe how they shift
compensated demand curves of X and Y due to variations in income or the
price of the other good.

It is known from theory that the derivatives of the expenditure function with respect to prices,
it allows obtaining the compensated demands (also called Hicksian) that depend
of utility and not of income (these are the uncompensated or Marshallian demands).

∂E U4PY
=X ( U , px , py) = −1
∂PX √ px
2U4p y

∂E U4PX
∂PY
=Y ( U, px, py
=
) 2U4p
√ px y

The compensated function of X depends on py, unlike the uncompensated function. In

both demands an increase in prices reduces the quantity.

Exercise 5.9

Comment:

An example of revealed preferences of inconsistent preferences.

Over a period of three years, an individual shows the following

consumption behavior.

Px Py X Y

Year 1 3 3 7 4

Year 2 4 2 6 6

Year 3 5 1 7 3

Is this behavior consistent with the strong axiom of preferences?

revealed?

The weak axiom of revealed preferences (WARP) states the following:

YesP∗X( P' I' ) ≤ I and

( ' X' ) P I( ≠ X) then
P, I it must be fulfilled that:

P' X ( P, I )> I '

This definition was taken from Mas-Colell, Whinston, and Green.

17
I 1=X Px+YPy =3∗7+3∗4=33

I 2=X Px+YPy =4∗6+2∗6=36

I 3=XPx +YPy =5∗7+1∗3=38

Checking the relationships:

P1X 2 <=I1

3∗6+3∗6 ≤ 3It3is fulfilled. The basket from year 2 is not accessible at the prices of year 1.

P1X 3 I1

3∗7+3∗3 i s Itl emust

s s happen,
t h a n othen
r eitqmust
u a ltake
t o place.
33

P 3X 1 > I 3

5∗7+1+4 >38Complies. The consumer having been able to chooseX 3 election1X. Then
X 1≻X3.

Let's compare X2 with 3X. It must be verified

P2X 3 ≤I2 y P 3 X>2 I 3

4∗7+2∗3 ≤ 3 6Fulfill

5∗6+1∗6>38It does not fulfill, therefore it violates the Weak Axiom.

The basket of year 2 is reported preferred to the basket of year 1, given that both cost the same.
the same as the prices of year 2. The basket of year 2 was also revealed to be preferred to the
basket of year 3 for the same reason. But in year 3, the basket of year 2 costs less.
that the basket of year 3, but this is not chosen. Therefore, it violates the axiom.

Exercise 5.10

Comment:

Present the concept of separable utility and show the types of relationships between goods.
for which a function is in some way limited.

Assume that an individual's utility function for three goods: X 1,X2X

,3 is
"separable"; that is to say, suppose that:

U ( X1 X 2 , X3=U(x)+U
) 1 x+U
( 2 )x ( 3)
WithU 'i >0Uyi< 0' '

18
 For i = 1, 2 or 3

Prove:

None of the assets can be inferior.

L=U (x+U
1) x+U
( 2 ) x+ (λI−
3 ) p1X−p
( 2 X 1−p 3 X 2 3 )
CPO:

∂L
=U X1−¿ p 1 λ =0 ¿
∂X1

∂L
=U X2−¿ p 2 λ =0¿
∂X2

∂L
=U X3−¿ p 3 λ =0 ¿
∂X3

∂L
=I − p 1 X 1− p 2 X 2− p 3 X 3=0
∂λ

Four equations and four variables constitute a determined compatible system (DCS). The
the maximization condition implies that:

UXUXUX
=
1
=
2
=λ
3

p1p2p3

If income increases, the quantity of one of the goods (for example, X1) should grow.
UX
(not all can be inferior). Then, should fall to maintain equality, the
1

p1
other amounts must also increase.

∂ Xi
b. <0
∂Pi

Since there are no inferior goods, all derivatives with respect to the price itself must
be negative.

Bibliography

Nicholson, Walter. "Microeconomic Theory. Principles and Applications". Eighth

edition.
Nicholson, Walter. “Teoría microeconómica. Principios y aplicaciones”. Undecima
edition.
Nicholson, Walter. “Solutions Manual and Test Bank. Microeconomic Theory”.
Seventh Edition.

19
Mas-Colell, Andreu; Whinston, Michael; Green, Jerry. “Microeconomic Theory”.
First Edition.

20