MICROECONOMICS – PROBLEM SET 1

CONSUMER THEORY - TEXTS

Prerequisites. Textbook references for the topics covered in this problem set are: Bernheim and
Winston, Microeconomics, Chapters 1, 2, 4 and 5. Further supplementary readings: Microeco-
nomics, Exercises, Notes on consumer choice.

This problem set consists of 2 sections: First section - True, false or uncertain; Second section -
Exercises. Most questions are taken from past microeconomics exams.

First Section – True, false or uncertain

Decide whether the following statements are TRUE, FALSE or UNCERTAIN (i.e. they
are true only under specific hypothesis not contained in the statement). Justify the
answer. [The justification is more important than the initial answer being true, false or
uncertain]

1) For Chris good X and good Y are perfect substitutes. Then he is always indifferent between
consuming bundle A=(2,1) or bundle B=(1,2) (where the first entry is the amount of good X and
the second entry is the amount of good Y).

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2) Serena likes both tennis shoes (good X) and tennis rackets (good Y). At her current
consumption bundle (where she spends all her income), her marginal rate of substitution of
rackets for shoes is 3, meaning that she is willing to trade 3 rackets for 1 pair of shoes. The price
for a racket is $200 (py=$200) and the price for a pair of shoes is $100 (px=$100). Serena could
increase her utility by consuming more rackets and less shoes.

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3) Given two goods, X and Y, if the indifference curve is horizontal, this means that by increasing
the consumption of good X, the consumer’s satisfaction increases.

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4) Daniele has regular preferences and consumes only books (good X) and magazines (good Y).
At Daniele’s best choice, the marginal utility of books is equal to 40 (MUx=40), whereas the mar-
ginal utility of magazines is equal to 20 (MUy=20). If the price of books (Px) is 8, then the price of
magazines (Py) will be equal to 5.

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5) The demand curve of a market is Q=1000-50p. When price is equal to 10, the price elasticity
of demand is -1.

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Second Section – Exercises

Exercise 1)

Greta consumes only books (good X) and phone cards (good Y). Greta is endowed with 800€
(M=800). The unitary price of books is 8 (px=8), while the price of each phone card is 10 (py=10).
Greta’s preferences over these goods are regular and could be represented by the following
(Cobb-Douglas) utility function: U(X,Y) = X0,4 Y0,6

a) Write down Greta’s budget line and draw it in the following graph. Indicate clearly the inter-
cepts and the slope of the budget line.

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b) Given the form of Greta’s preferences over good X and good Y, the marginal rate of substitu-
tion is MRS=MUx/MUy=(2/3)(Y/X). Compute Greta’s optimal consumption bundle. Draw it in
the previous graph.
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c) After a year, because of inflation, the unitary price of books rises from 8 to 12 and the price of
phone cards from 10 to 15. Compute by how much Greta’s monthly income will have to increase
so that in equilibrium she will be able to obtain the same level of utility as the previous year?

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Exercise 2)

Francesco has 15€ (M=15) and wants to buy sweets (good X) and wine (good Y). The unitary
price of wine is 5€ (py=5), while the unitary price of sweets is 1€ (px=1). Francesco is always
willing to swap sweets for wine at a fixed rate; in particular he is always willing to give up a
sweet in exchange for 1/4 extra units of wine.

a) Write down Francesco’s utility function.

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b) Write down the equation for Francesco’s budget line and draw it in the following graph. Indi-
cate clearly the intercepts and the slope.

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c) You know that the MRS is equal to ¼=0.25. Find Francesco’s best choice and represent it in
the previous graph.

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d) What must be the price of the wine so that Francesco is willing to consume any combination of
wine and sweets which belong to his budget line?

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Exercise 3)

Mr. Bonaparte always consumes cappuccino and biscuits in a fixed proportion; in particular he
loves having a cup of cappuccino (good C, on the horizontal axis) and 2 biscuits (good B, on the
vertical axis) for breakfast. The weekly income which he can spend on breakfast is equal to 21€
(M=21); the unitary price of a cup of cappuccino is 1.5€ (pC=1.5) and the unitary price of biscuits
is 1€ (pB=1).

a) What kind of preferences are we dealing with in this case? Write down a utility function that
could be consistent with Mr. Bonaparte’s preferences and draw it in the following graph.

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b) How many times a week can Mr. Bonaparte have breakfast drinking cappuccino and eating
biscuits? Find Mr. Bonaparte’s best affordable basket.

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c) If Mr. Bonaparte would like to have cappuccino and biscuits for breakfast every day of the
week, what should his income be equal to?

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Further questions and exercises on the same topics of Problem set 1:

Workbook “Microeconomics – Exercises”

 Chapter 1 – CONSUMPTION DECISIONS

 On-line applications on the same topics available @

http://mybook.egeaonline.it. Use the personal code reported in the inside cov-
er of your workbook to access.