Intermediate Microeconomics

Spring 2016
Homework 1: Budget constraint - Preferences and Utility - Choice
Instructor: Caixia Shen

The due date for this homework is March 17th, 2016 (Thursday). Note that
you only need to do 1, 2 and 3. Problem 4-10 are optional. Answer keys to all
questions will be provided later.

1. The consumption basket of Amy consists of comic books and candy bars. Let x1 and
x2 be their quantities respectively. Everyweek, his parents give her 100 yuan. Assume
the price of one book is 10 yuan, while the price of one candy bar is 2 yuan.

(a) Write down her budget constraint. And draw her consumption set.
(b) What happens to her consumption set if the price of candy bar is higher? if her
parents give her more money? If she can not read more than 5 books a week?
(c) Let’s say her utility function is U (x1 , x2 ) = 10x1 + 2x2 . What can we say about
those two goods? Draw her indifference curves.
(d) Compute her marginal utility and marginal rate of substitution.

2. Jack’s preferences are given by the utility function U (x1 , x2 ) = ln x1 + x2 .

(a) Draw his indifference curves.

(b) The price of good 1 is 2 yuan and the price of good 2 is 1 yuan, whereas his
income is 8 yuan. Draw his budget line in the same graph.
(c) Write down his budget constraint. Solve analytically his optimal choice.

3. For the following sets of goods draw two indifference curves, U1 and U2 , with U2 > U1 .
Draw each graph placing the amount of the first good on the horizontal axis.

(a) Hot dogs and chili (the consumer likes both and has a diminishing marginal rate
of substitution of hot dogs for chili).
(b) Sugar and Sweet’N Low (the consumer likes both and will accept an ounce of
Sweet’N Low or an ounce of sugar with equal satisfaction).
(c) Peanut butter and jelly (the consumer likes exactly 2 ounces of peanut butter for
every ounce of jelly).
(d) Nuts (which the consumer neither likes nor dislikes) and ice cream (which the
consumer likes).
(e) Apples (which the consumer likes) and liver (which the consumer dislikes).

4. (OPTIONAL)James Bond likes his vodka martinis to contain exactly 10 parts of

vodka for every 1 part of vermouth. On a graph with the amount of vodka on one axis
and the amount of vermouth on the other axis, draw two of his indifference curves,
U1 and U2 , with U2 > U1 . Hint: His preferences can be described by U (X, Y ) =
M in(X, 10Y ).

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5. (OPTIONAL) Marginal Rate of Substitution.

(a) Give a definition of the marginal rate of substitution that does not use the words
”utility” or ”slope.”
(b) Now, using words, figures, or simple examples, show why a consumer’s marginal
rate of substituion between goods X and Y is equal to the slope of the consumer’s
indifference curve, which is equal to M UX = M UY .
(c) Assume U (X, Y ) = X a Y b . At any given (X, Y ), what is the consumer’s marginal
rate of substitution? At (3; 1)? At (1; 3)? Hint: M UX = aX a−1 Y b , M UY =
bX a Y b−1 , and your answers will be interms of a and b.
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(d) Repeat part ”c” with U (X, Y ) = X 2 + Y . Hint: M UX = 21 X − 2 and M UY = 1.
(e) Again, with U (X, Y ) = X + Y . Hint: M UX = 1 and M UY = 1.
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(f) And finally, with U (X, Y ) = (X + Y ) 2 . Will consumers with the preferences in
”f” always make the same choices as consumers with the preferences in ”e”? Hint:
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M UX = .5(X + Y )− 2 and M UY = .5(X + Y )− 2 . For the second part, choose a
few random bundles of goods and calculate levels of utility given the two types of
preferences. How do the rankings compare?

6. (OPTIONAL) Let’s consider Julie’s preferences for food F and clothing C. Her utility
function was U (F, C) = F C. Her marginal utilities were M UF = C and M UC = F .
Suppose that food costs $1 a unit and that clothing costs $2 a unit. Julie has $12 to
spend on food and clothing.

(a) Using a graph (and no algebra), find the optimal (utility-maximizing) choice of
food and clothing. Let the amount of food be on the horizontal axis and the
amount of clothing be on the vertical axis.
(b) Using algebra (the tangency condition and the budget line), find the optimal
choice of food and clothing.
(c) What is the marginal rate of substitution of food for clothing at her optimal
basket? Show this graphically and algebraically.
(d) Suppose Julie decides to buy 4 units of food and 4 units of clothing with her $12
budget (instead of the optimal basket). Would her marginal utility per dollar
spent on food be greater than or less than her marginal utility per dollar spent
on clothing? What does this tell you about how she should substitute food for
clothing if she wanted to increase her utility without spending any more money?

7. (OPTIONAL) Consider a consumer with the utility function U (x, y) = min(3x, 5y),
that is, the two goods are perfect complements in the ratio 3:5. The prices of the two
goods are P x = $5 and P y = $10, and the consumer’s income is $220. Determine the
optimum consumption basket.
8. (OPTIONAL) Redo Problem 7 with U (x, y) = 3x + 5y and U (x, y) = 5x + 3y.
9. (OPTIONAL) Samantha purchases food (F ) and other goods (Y ) with the utility
function U = F Y . Her income is 12. The price of a food is 2 and the price of other
goods 1.

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 (a) How many units of food does she consume when she maximizes utility?
(b) The government has recently completed a study suggesting that, for a healthy diet,
every consumer should consume at least F = 8 units of food. The government is
considering giving a consumer like Samantha a cash subsidy that would induce
her to buy F = 8. How large would the cash subsidy need to be? Show her
optimal basket with the cash subsidy on an optimal choice diagram with F on
the horizontal axis and Y on the vertical axis.

10. (OPTIONAL) Proof (Hard) Suppose U (X, Y ) is a utility function such that the
consumer’s utility maximization problem will always yield an interior solution. Using
words, figures, or simple examples, show that when a consumer is behaving optimally
he must be at a bundle where his inidfference curve is tangent to his budget constraint.