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are goods (more is better) but after a threshold level each of them becomes a

bad (more is worse). Draw an indifference curve for the case described and

clearly identify the better than set.

2. Consider two goods x1 and x2, with M= $100, p1=1, and p2=2. Place x2 on

the vertical axis and x1 on the horizontal axis. Label the budget lines as

noted in parentheses.

b. Draw a new budget line with M= $100, and p2=2

c. Draw a new budget line with prices as in part a., M = $200, and a coupon

allowing consumption of 20 units of good 1. The coupon can be purchased

for $5

blnx2

a. Do U and V represent the same preferences? Prove your point

mathematically.

4. Walt consumes strawberries and cream but only in the fixed ratio of three

boxes of strawberries to two cartons of cream. At any other ratio, the excess

goods are totally useless to him. That is, his utility function is given by U(S,

C)=min (3S,2C). The cost of a box of strawberries is $10 and the cost of a

carton of cream is $10. Walts income is $200. What is Walts demand for

strawberries and cream?

5. a. Generate the cost function for the production function y=x1 1/4 x2 1/2

when W1=1 and w2=10. You can use the Lagrangean approach or make a

solid argument about the optimality conditions. If you do the latter use a

diagram to bolster your argument.

b. Using the first order conditions for profit maximization derive the supply

function for all prices greater than zero.

c. What are firm profits if p=1? Does the firm choose to operate?

represent capital and labor respectively. Show either analytically (using

symbols only) r numerically that increasing returns to scale is associated with

the condition a+b>1 and decreasing returns to scale with a+b<1.

(ii) What are the implications for cost and optimal output if the production

function has increasing returns to scale. Use a diagram of your choice to

demonstrate the implications of increasing returns to scale.

7. Consider the utility fuction U(x1, x2) = x1 a x b and the budget constraint

m = p1x1 + p2x2. You can assume that a and b are between 0 and 1 and that

a+b=1

a. Explain in plain English and with a graph why the utility maximizing choice

occurs where the slope of the budget line and the slope of the indifference

curve are equal.

b. Derive the optimality conditions associated with part a. for the utility function

using the Lagrangean approach.

c. Solve the ordinary demands x1* and X2* using the budget constraint to pin

down a specific level of demand. (Remember you should solve so that each

good is expressed in terms of prices, income, and preference parameters, not

the other x). Are your demands downward sloping?

d. Rearrange the expression you derived for x1* so that the preference

parameters a, and b, are isolated on one side of the equality. Interpret the

meaning of the expression defined by the preference parameters in terms of

the other variables (x, p, and M).

8. Suppose that the optimality conditions in a consumer choice problem are not

satisfied and the MRS is greater that the ratio of the good prices. Assume also

that the consumer is consuming some of each good and has well behaved

convex preferences. Would the consumer want to adjust their consumption by

increasing x1 or x2? Why? Draw a diagram and show the direction

adjustment.

problem inappropriate when goods are perfect substitutes? Use math, a

graph and in plain English explain your reasoning.

10.Consider the case of concave preferences in which the worse than set is

convex and the better than set is not. Draw an example of an indifference

curve that is smooth that meets the requirements for concave preferences.

Explain why the optimality conditions are relating the marginal rate of

substitution to the price ratio are not helpful for determining optimal choice.

(Hint: draw more than one indifference curve and a budget line).

11.A thirsty fox is walking down a path and sees a bundle of grabs hanging from

a branch of grape tree. The fox tries repeatedly to reach the grapes but is

unable to do so. As he walks away he thinks, those grapes were probably

sour anyway. Explain how his reasoning is inconsistent with the rational

choice diagram.

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