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Tramontana Altervista Org Files Exercises Consumer Theory
Tramontana Altervista Org Files Exercises Consumer Theory
Choice
Exercises of Microeconomics
Utility Maximization - Choice (Ch. 7-8 Varian)
Tramontana
Exercises Micro
Utility Maximization
Choice
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Exercise 7.1
Consider preferences dened over the nonnegative orthant by
(x1 , x2 ) (y1 , y2 )
if x1 + x2
< y1 + y2 .
local nonsatiation?
If these are the only two consumption goods and the consumer
faces positive prices, will the consumer spend all of his income?
Explain.
Tramontana
is some bundle y in X
x.
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
In other words,
bundle.
but it exists.
In our case the bundle
(0, 0)
exists.
So our consumer does not spend any amount of income.
It is not a real good what we are talking about.
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Exercise 7.2
= max {x1 , x2 }.
What is
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
So, the demand functions are
xi
m/pi
if
pi
0 or m /pi
if
pi
if
pi
< pj
= pj
> pj
e (p , u ). In our case:
e (p1 , p2 , u ) = u min {p1 , p2 } .
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 7.1
Exercise 7.2
Utility Maximization
Exercise 7.3
Choice
Exercise 7.4
Exercise 7.5
Exercise 7.3
A consumer has an indirect utility function of the form
v (p1 , p2 , m) =
m
min {p1 , p2 }
v (p1 , p2 , m) =
m/p1
if
p1
m/p
if
p1
m/p2
if
Tramontana
< p2
= p2
p1 > p2
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
The best thing consists in starting from the demand function.
In fact, it is clear that the consumer will use all his income for the
good with the lowest price:
x1
m/p1
if
=m
if
if
p1
< p2
= p2
p1 > p2
p1
u (x1 , x2 ) = x1 + x2
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
Finally, we must obtain the expenditure function, so a measure of
how much the consumer should spend in order to reach a certain
level of utility, given the goods' prices.
Our consumer spends:
xi pi
where i denotes the good with the lowest price.
But the quantity of the good i is equal to m /pi that is also the
amount of utility reached.
In other words:
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Exercise 7.4
Consider the indirect utility function given by
v (p1 , p2 , m) =
m
p1 + p2
(a) What are the demand functions? (b) What is the expenditure
function? (c) What is the direct utility function?
xi (p , m) =
Tramontana
v (p ,m)
pi
v (p ,m)
m
Exercises Micro
Exercise 7.1
Exercise 7.2
Utility Maximization
Exercise 7.3
Choice
Exercise 7.4
Exercise 7.5
Solution
v
p1
v
m
= pv = (p
= p +1 p
2
m
1
+p2 )2
x1 (m, p ) = x2 (m, p ) =
m
p1 + p2
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
= x1 p1 + x2 p2
m
p1 + p2
Tramontana
p1 +
m
p1 + p2
p2
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
We know that the level of utility rechaed is exactly u
m
p1
+p2 , so
we have:
e (p1 , p2 , u ) = (p1 + p2 )u
The direct utility function relates the level of utility with the
amount of goods consumed: u (x1 , x2 ).
We know that the consumer buys the same amount of the two
goods:
x1
= x2 =
m
p1 + p2
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Exercise 7.5
U (x1 , x2 ) = u (x1 ) + x2 .
Good 1 is a discrete good; the only possible levels of consumption
of good 1 are x1
=0
and x1
= 1.
that u (0) = 0
and p2
= 1.
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Exercise 7.5(b)
=1
if p1 is strictly less
than what?
=0
and with x1
= 1.
If the consumer only consumes the good 2, given that its price is
equal to 1 and given that (from the utility function) there is 1-1
correspondence between level of utility and amount of good 2, we
have:
u |x =0
1
Tramontana
=m
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
u |x =1
1
= u (1) + m p1
Now, in order to make the consumer preferer the situation with one
unity of good 1, this condition must be realized:
u |x =0
1
Tramontana
< u |x
=1
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Solution
That is:
p1
< u (1).
Tramontana
Exercises Micro
Exercise 7.1
Utility Maximization
Choice
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Exercise 7.5(c)
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Exercise 8.5
= 100.
L (x , ) =
3
2
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
The rst order conditions are obtained by dierentiating the
Lagrangian function with respect to x1 , x2 and
3 = 0
4 = 0
x
3x1 + 4x2 100 = 0
2x1
1
2
=
=
1
2x1
1
4x2
x1
Tramontana
= 2x2
Exercises Micro
These derivatives
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
By substituting x1
= 2x2
= 100
x2 = 10
and then:
x1
= 20;
x2
Tramontana
= 10; =
Exercises Micro
1
40
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Exercise 8.6
1
= p1 x1 + p2 x2
to calculate
L (x , ) = x1 x2 (p1 x1 + p2 x2 m)
while the f.o.c. are:
1
2
1
3
21
x1
x23
23
x12 x2
= p1
= p2
=m
p1 x1 + p1 x2
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
x1 (p , m) =
x2 (p , m) =
3 m
5 p1
2 m
5 p2
v (p , m ) =
3 m
5 p1
2
2 m
5 p2
Tramontana
m
6
Exercises Micro
p1
2
p2
1
3
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
u
e (p , u )
6
p1
p2
e (p , u ) = 5
p p
Tramontana
2
5
u5
Exercises Micro
1
3
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
One of the properties of the expenditure function is the following:
Property of e (p , u )
If h (p , u ) is the expenditure-minimizing bundle necessary to achieve
utility level u at prices p (Hicksian demand), then
hi (p , u ) =
e (p , u )
pi
for i
= 1, ..., k
h1 (p , u ) =
h2 (p , u ) =
e (p ,u )
p1
e (p ,u )
p2
Tramontana
p1
p1
2
5
p2
2
5
3
5
p2
Exercises Micro
3
5
u5
6
u5
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Exercise 8.7
Extend the previous exercise to the case where
hj (p ,u )
.
pi
h
i
L (x , ) = p1 x1 + p2 x2 (x1 1 ) (x2 2 ) u
1
= 1 (x1 1 ) 1 (x2 2 )
p2 = 2 (x1 1 ) (x2 2 ) 1
(x1 1 ) (x2 2 ) = u
p1
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
If we divide the rst equation by the second we obtain:
p1 2
p2 1
x2 2
x1 1
x2 2
h
i
= (x1 1 ) u
h1 (p , u ) = 1 +
Tramontana
p2 1
p1 2
u 2
2
1 +2
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
h2 (p , u ) = 2 +
p1 2
p2 1
u 1
1
1 +2
"
#
h1 (p , u ) h2 (p , u )
1
2
u
=
=
p2
p1
1 + 2 p1
p2
2
Tramontana
Exercises Micro
1
1 +2
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
The expenditure function is obtained by using the Hicksian
demands in p1 x1 + p2 x2 :
e (p , u ) = p1 1 +
p2 1
p1 2
u 2
2
1 +2
+ p2 2 +
p1 2
p2 1
u 1
1
1 +2
1
v (p , m ) =
1 + 2
m 2 p2
p1
1
Tramontana
2
1 + 2
Exercises Micro
m 1 p1
p2
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
x1 (p , m) = +
1
2
1
x2 (p , m) = +
1
2
Tramontana
1 2 + 2 m
p
m
2 1 + 1 p
1 p1
2
2 p2
Exercises Micro
.
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Outline
Utility Maximization
Exercise 7.1
Exercise 7.2
Exercise 7.3
Exercise 7.4
Exercise 7.5
Choice
Exercise 8.5
Exercise 8.6
Exercise 8.7
Exercise
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
= log(x1 ) + M
maxU
x1 M
= log(x1 ) + M
s .t . Y
Tramontana
= M + p1 x1
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
The Lagrangian is the following:
L (x1 , M , ) = log(x1 ) + M (M + p1 x1 Y )
The f.o.c. are:
L
x1
L
M
L
= x p1 = 0
= = 0
= Y M p1 x1 = 0
1
x1
Tramontana
p1
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
= ,
x1
so:
.
p1
Note that the demand for the good 1 is independent of income (has
zero income elasticity).
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Exercise (b)
min M
x1 M
s .t . u
+ p1 x1
= log(x1 ) + M
L (x1 , M , ) = M + p1 x1 + [ log(x1 ) + M u ]
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
The f.o.c. are:
L
x1
L
M
L
= p1 x = 0
= 1 = 0
= u log(x1 ) M = 0
1
x1
p1
x1
= 1/ :
p1
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Exercise (c)
Tramontana
Exercises Micro
Exercise 8.5
Utility Maximization
Exercise 8.6
Choice
Exercise 8.7
Exercise
Solution
In our case the demand for the good 1 has zero elasticity (that
is, it's independent) both with respect to income and to
respect to utility. It only depends on the parameters and on
the price of the good. This is why the two demands are equal;
Obviously, this cannot be considered a general result, but only
what happens in this peculiar case.
Tramontana
Exercises Micro