University of Toronto Mississauga Department of Economics

ECO 209Y - Macroeconomic Theory and Policy Prof. Kambourov Tutorial 3 Suggested Answers
October 10-15, 2012. 1. Consider the consumer problem in the case when consumption and leisure are perfect complements. This case is described in detail on pages 105-107 in the textbook. Then, answer the following question: Assume that the consumer always desires a consumption bundle where the quantities of consumption and leisure are equal, that is a = 1. (a) Suppose that w = 0.75, = 8, T = 6, and h = 16. Determine the consumers optimal choice of consumption and leisure, and show this in a diagram. (b) Now suppose that w = 1.5, = 8, T = 6, and h = 16. Again, determine the consumers optimal choice of consumption and leisure, and show this in your diagram. Explain how and why the consumers optimal consumption bundle changes, with reference to income and substitution eects. Suggested Answers Discuss the case when consumption and leisure are perfect complements as described on pages 105-107 in the textbook. Then, proceed with the question. The budget constraint for the consumer is c = 0.75(16 l) + 8 6, and since perfect complements with a = 1 implies that the consumer wishes to equalize leisure and consumption, this gives c = l. Then, substituting in the above equation and solving for c, we get c = l = 8.

 If the wage doubles for the consumer to 1.5, then going through the same procedure, we solve for consumption and leisure to get c = l = 10.4. Thus, consumption and leisure both increase. Given perfect complements, there is no substitution eect, only an income eect. When the wage increases there is a positive income eect on both consumption and leisure, and so both quantities increase. It is straightforward to draw a diagram as in Figure 4.11 in the text with the budget constraint shifting out and the quantities of consumption and leisure increasing when the budget constraint shifts.