Microeconomics - Seminar 2

1. Utility function with MRS -2, u(X1, X2) = 2X2 + X1

-X2/X1 = -2

Budget constraint with slope = P1/P2 = -4/3

X2

Indifference curves
with slope -2

Optimal point is a boundary optimum

where only good 1 is consumed

X1
Budget constraint
with slope -3/4

A,B and D

2.

U = (ax1p + bX2P)1/p

Du/dX1 = 1/p((ax1p + bX2P) 1/p -1 (pax1p – 1)

Du/dX2 = 1/p((ax1p + bX2P) 1/p -1 (pbx2p – 1)

MRS = -dx2/dx1 = -Du/dX1 / Du/dX2

= - 1/p((ax1p + bX2P) 1/p -1 (pax1p – 1) / 1/p((ax1p + bX2P) 1/p -1 (pbx2p – 1)

= - ax1p – 1 / bx2p – 1

= - ax11-p (-1)/ bx21-p(-1)

=
-a/b (x11-p)-1/ (x21-p)-1
=
-a/b(x21-p)/ (x11-p)

= -a(x21-p)/b(x11-p)

=B

3. Utility function U(X1,X2) = U X1X2 = cobb-douglas preference

Budget constraint = 10X2 + 10X1 (if X1≤ 6) = 100

= 10X2 + 5X1 (if X1 > 6) = 100

Kinked budget constraint

Optimal solution for a Cobb-Douglas preference:

X1* = 100(1)/(1+1)(10)

if X1≤ 6

So X1* = 5

X1* = 100(1)/(1+1)(5)

if X1> 6

So X1* = 10

X2* = 100(1)/(1+1)(10)

So X2* = 5

MRS = -X2/X1 = -1 or -1/2

X2 = 7-1/2X1

So optimal bundles either (5,5) or (10,5) x

A
 4. 𝑢 = 2X1 + X2

Budget constraint:

4X2 + 4X1 if X1 ≤ 5 = budget

4X2 + 2X1 if X1 > 5 = budget

MRS of utility function = -1/2

Slope of budget constraint = -1 or -1/2

When his budget is less than 20, the most of good 1 he can consume is 5 so the price of good 1 is 4
and the slope of the budget constraint (-1) is steeper than the MRS (-1/2) so the optimal
consumption point is a boundary optimum and consumption of good 1 is 0. Only good 2 is
consumed.

When his budget is greater than 20, he can afford more than 5 of good 1 the price of good 1 reduces
to 2 and the MRS of the utility function is equal to the slope of the budget constraint (-1) so he is
indifferent between consuming goods 1 and 2 and any proportion of both is an optimal bundle

E
X2

MRS = -1/2

X1

Budget constraint = -1

5. A

6. 𝑢 = √𝑥1𝑥2

X1h = √𝑥1𝑥2 (P2/P1 x ½ / 1-1/2)1-1/2

X1h = √𝑥1𝑥2 (P2/P1)1/2

X1h = u bar (P2/P1)1/2

C
Deriving the equation:

L = -(p1x1 +p2x2) + lambda (root x1x2 – ubar)

(note – shows it’s a minimisation problem)

dL/dx1 = -p1 + lambda rootx2/rootx1 x ½ = 0

dL/dx2

x2/x1 = p1/p2

x2 = p1/p2 x1

substitute

ubar =root( x1 squared x p1/p2)

= x1 x root (p1/p2)

7. If some function f(.) represents a positive monotonic transformation, then utility function
f(U) represents the same preferences as utility function U (original function)

Check for positive and negative values

A, C, D

C not for negative values of either X or Y ….

G not for negative values of either X or Y

F, the negative reverses the order so not the same preferences

V with MRSv and u with Mrsu

If MRSv = MRSu then V = u so same preferences if order is also same

Compute MRS and check

Must be written as xy and not components separately

8.

Maximise (X11/2 + X21/2)2

St. M ≥ X1P1 + X2P2

M - X1P1 + X2P2 = 0

L = (X11/2 + X21/2)2 + lambda(M - X1P1 + X2P2)

dL/dX1 = 2(X11/2 + X21/2)(1/2X1-1/2) -lambdaP1= 0

dL/dX2 = 2(X11/2 + X21/2)(1/2X2-1/2) -lambdaP2= 0

dL/dlambda = (M- X1P1 + X2P2) = 0

2(X11/2 + X21/2)(1/2X1-1/2)/ 2(X11/2 + X21/2)(1/2X2-1/2) = P1/P2

X1-1/2 / X2-1/2 = P1/P2

X21/2 / X11/2 = P1/P2

X2 = (X11/2 P1/P2 )2

X2 = X1 (P1/P2)2

M - X1P1 + X2P2 = 0

Replacing X2 in the equation above:

M - X1P1 + X1 (P1/P2)2 (P2 )= 0

X1((P1 - (P1/P2)2 (P2)) = M

X1 = M/ P1 – (P12P2)

X2 = M/ P1 – (P12P2) (P1/P2)2

X2 = M/ P1 – (P12P2) (P12/P22)

X2 = M/ P1 – P23

Budget share of good 1: P1X1 =

Budget share of good 2: P2X2 =

9a)

Optimal consumption before price rise

X1* before = M(1) / (1+1) 9

= M/18

X1* after = M(1) / (1+1) 16

= M/32

X1h = 𝑥1𝑥2

1. Derive hicksian demand function

X1h = root p2/p1 x root ubar

X2h = root p1/p2 x root ubar

2. Compute expenditure

E (p1 = 9, p2) = p1x1 +p2x2 = (substitute from above)

= 6 root(ubar p2)

E(P1 = 16,p2) = 2 root (ubar p1p2) = 8 root (p2 ubar)

Change E = 2 root(ubar p2)

E(p1 = 16, p2(1-s)

= 8 root(p2 (1-s) ubar)

So S = s p2 x2h

7/17 p2 root (16/p2 x 9/16) x root ubar

= 7/3 root(ubar p2)

Compare the values

7/2 > 2 so a lump sum transfer is preferred