COBECON 3rd Term, AY 2022-23

Reviewer: Consumer behavior J.Tanchuco

1.)Consider the following graph of a consumer optima. In this graph, there are three indifference curves
shown (colored blue curves) and a single (red colored) budget line.

X
X and Y are two outputs in consumer's basket

a a'
b

c
Y

i.)Do you agree that points a and c are considered representing sub-optimal points ? Answer yes
or no but justify your answer. Do you agree that at point a, the following inequality applies:
MUX /PX < MUY/PY? Answer yes or no but justify your answer. Do you agree that at point c, the
following inequality applies: MUX/PX > MUY/PY? Answer yes or no but justify your answer.

ii.Do you agree that consumer optimal combination of outputs X and Y is represented by point
b in this graph? Answer yes or no but justify your answer. Do you agree that at point b, the
following equality applies: MUX/PX = MUY/PY? Answer yes or no but justify your answer.

iii.)At point a', consumer will be experiencing a higher total utility (satisfaction) level. Do you
agree that point a' is an impossible output combination for the consumer? Answer yes or no but
justify your answer.

2.) Consider the following graphs of consumer optima with changes in the output price ratio(P X/PY). In
all three graphs, point e is the initial point of consumer optima while e' is the new point of consumer
optima (due to the alteration into the price of output X, Px).

X X X

e'
e'
e

Y Y Y

i.) The graph in the middle represents a decrease in the price of output X, Px. Do you agree that
this reduction in the price of output X will increase optimal quantities of X? Answer yes or no
but justify your answer. What market interventions can possibly cause the price of output X to
decrease?

ii.)The graph in the right represents an increase in the price of output X, Px. Do you agree that
this increase in the price of output X will decrease optimal quantities of X? Answer yes or no but
 justify your answer. What market interventions can possibly cause the price of output of X to
increase?

3.) Consumer's utility function is represented by U = 40X0.25Y0.75. In this utility function, U is the total
utility while X and Y are two outputs in the consumer's basket. The corresponding marginal utilities
function will be MUx = ΔU/ΔX = 10X-0.75Y0.75 and MUy = ΔU/ΔY = 30X0.25Y-0.25 for output X and Y
respectively. Using these marginal utility functions, the relevant marginal rate of substitution (that is,
willingness to substitute between output X and Y) of the consumer will be MRS = - MUx/ MUy = - 10X-
0.75 0.75
Y /30X0.25Y-0.25 = -1/3Y/X. Using the information provided in this item, answer the following
questions.

i.)What is the meaning of the marginal rate of substitution (MRS) of -1/3Y/X? Why is the MRS
preceded by a negative sign? What is the relevance of this MRS to the consumer? What is the
relevance of this MRS to the seller(s) of output X and output Y?

ii.)The prices of both outputs is 5 pesos (that is Px = 5 pesos = Py) and consumer's income is
equal to 50,000 pesos. What is the consumer's optimal condition considering marginal utilities,
output prices and consumer's income?

iii.)What will be the optimal combination of outputs X and Y considering output prices and
consumer's income?

iv.) Demonstrate that at the optimal combination of output, [consumer optimal condition]
MUX/PX = MUY/PY

4.)What is the concept of diminishing marginal utility? What is the relevance of this concept into
explaining consumer behavior? What is the relevance of this concept to any seller?

5.) Previously, demand is defined as the relationship between prices and quantities that consumers are
able and willing to buy. An alternative definition of demand is a locus of points representing various
consumer optima. Do you agree with the latter statement? Answer yes or no but justify your answer.

6.)The typical utility function of a electricity consumer is represented by U = 400NR0.5R0.4 with U as the
total utility of the consumer from electricity while NR and R represents non-renewable and renewable
electricity (in kilowatts).Notice that the relevant marginal utilities will be MUNR = 200NR-0.5 R0.4 for non-
renewable electricity and MUR = 160NR0.5R-0.6 for renewable electricity. It was previously determined
that the average income of consumers in this electricity grid is equal to 30,000 pesos while the price of
non-renewable and renewable electricity is equal to [PNR] 10 pesos and [PR] 20 pesos respectively. Using
all these information, answer the following questions.

i.)What is the optimal consumer condition -MUNR/MUR = -PNR/PR or MUNR/ PNR = MUR/PR for the
consumers in this electricity grid? Afterwards, provide a brief interpretation of the resulting
optimal consumer condition.

ii.)What will be the optimal quantities of non-renewable and renewable electricity that
consumers will buy considering average incomes of 30,000 pesos and the prices of non-
renewable electricity and renewable electricity is 10 pesos and 20 pesos respectively?
 iii.)Government imposes an indirect tax of 100% into the use of non-renewable electricity. The
imposition of indirect taxes was prompted by the need to reduce pollution and carbon
emissions from non-renewable electricity generation. What will be the new optimal quantities
of both non-renewable and renewable electricity by the consumer?

7.)Allocation efficiency of the consumer refers to the maximization of total utility considering incomes
and output prices. Do you agree that consumer optima condition MUX/PX = MUY/PY can be likewise
considered as allocation efficiency condition in the case of the consumer? Answer yes or no but justify
your answer.

8.)Consider the basic necessities utility function U = F0.3NF0.7 of consumers in a developing economy. In
this utility function, U represents total utility (or benefits from food and non-food expenditures) while F
is food and NF is non-food expenditures. Marginal utility functions for both food and non-food
expenditures of consumers will be MUF = 300F-0.7NF-0.3 and MUNF = 700F0.3NF-0.3 respectively. Use the
information provided to answer the following questions.

i.)Determine consumer optimal condition -MUF/MUNF =-PF/PNF of consumers in this

developing economy.

ii.)The demand for an output can be considered a locus of consumer optima points. Determine
the food and non-food demand functions of consumers in this economy. The demand functions
can be determined by substituting the optimal consumer condition into the budget line
equation.

iii.)Use the consumers' demand functions for food and non-food and an average income of
50,000 pesos to fill up the blanks in the following table.

PF F PNF NF
5 15
6 20
7 25
8 30
9 35

iv.)Can you consider the consumers' demand for food and non-food to be normal goods?
Answer yes or no but justify your answer using the relevant consumers' demand functions for
food and non-food. Can you consider the consumer's demand for food and non-food to be
inversely (or negatively) related to respective prices? Answer yes or no but justify your answer
using the relevant consumers' demand functions for food and non-food.

9.) Maximization of allocation efficiencies is not necessarily socially optimal. Answer yes or no but
justify your answer. Consider instances of wasteful, profligate consumption, vices and inadequate
allocation of consumer resources (such as health insurance, education and environmentally adverse
consumption behavior)
10.)Consider the allocation efficiencies of a consumer and the extension of a direct subsidy. Do you
agree that the extension of an income subsidy to consumers can still result into a maximization of
allocation efficiencies? Answer yes or no but justify your answer.

Answers to selected numbers.

3.)

i.)The consumer is willing to substitute 1 unit of Y for every 3 units of X. The negative sign indicates the
substitution that consumer must undertake between output X and Y while maintaining the same total
utility level. The relevance of MRS to consumer: output Y provides more incremental satisfaction than
output X's incremental satisfaction (on per unit basis and considering prices of the two outputs are the
same). For the seller, the MRS indicates how consumers can be induced to either buy more(less) of one
output relative to the other output.

ii.)For this problem, MRS is equal to - MUx/ MUy = - 10X-0.75Y0.75/30X0.25Y-0.25 = - 1/3Y/X (consider the MRS
as the slope of the indifference curve for the utility function U = 40X0.25Y0.75). The output price ratio -
Px/Py (or the slope of the budget line) will be -5/5 or -1. This will imply that relevant consumer optimal
condition - MUx/ MUy = -Px/Py = 1/3Y/X = 1 or 1/Y = X or Y = 3X.

iii.)Using this optimal condition into the budget line equation, 50,000= 5X + 5(3X) implies that consumer
buys optimal quantities of X* = 2,500 units. Since it was determined that Y = 3X, then for optimality
consumer will buy Y* = 7,500 units.

iv.)To demonstrate equality into the optimal consumer condition: - MUx/ MUy = -Px/Py. This optimal
condition can be likewise expressed as MUx/ Px = MUy/Py. Using the provided information and optimal
quantities of output X and Y will result in:

10(2,500)-0.75(7,500)0.75/5 = 30(2,500)0.25(7,500)-0.25/5 or 0.0526 = 0.0526

6.)

i.)In this problem, -MUNR/MUR = -PNR/PR = -200NR-0.5 R0.4/160NR0.5R-0.6 = -10/20 which can be simplified
into 1 1/4R/NR = ½ or R = 2/5NR. This optimal condition indicates consumer is willing and able to
substitute 2/5 units of renewable electricity for every 1 unit of non-renewable electricity considering the
prices (that is 10 and 20 pesos) of both types of electricity.

ii.)Using the optimal consumer condition R = 2/5NR into the budget line equation,

30,000 = 10NR + 20(2/5NR)

Indicates that consumer will buy optimal quantities of non-renewable electricity NR* = 1,666 2/3
kilowatts and R* = 2/5(1,666 2/3) = 666 2/3 kilowatts of renewable electricity.

iii.)The imposition of 100% tax will increase non-renewable electricity prices to 20 pesos per kilowatt-
hour (that is P'NR = 20 pesos). This will alter the optimal condition into 1 ¼ R/NR = 20/20 = 1 or R =4/5NR.
Using the changed optimal condition into the same budget line equation,
 30,000 = 20NR + 20(4/5NR)

Will reduce non-renewable electricity consumption to NR*' = 833 1/3 kilowatts while renewable
electricity consumption R* remains the same at 666 2/3 kilowatts (that is, 4/5 X 833 1/3)

8.)

i.) -MUF /MUNF = - PF/PNF = - 300F-0.7NF-0.3 /700F0.3NF-0.3 = - PF/PNF. This expression can be transformed
into:

3NF/7F = PF/PNF or NF = 2 1/3 FPF/PNF or F = 3/7NFPNF/PF

ii.) Using the optimal consumer condition NF = 2 1/3 FPF/PNF into the budget line equation,

I = PFF + PNF(2 1/3 FPF/PNF)

This expression can be simplified into I = 3 1/3PFF or F = I/3 1/3PF. The latter expression is the appropriate
food demand function for consumers in this economy. To determine the demand function of
consumers for non-food, the optimal consumer condition F = 3/7NFPNF/PF must be used. Substituting
this expression into the budget line equation,

I = PF(3/7NFPNF/PF) +PNFNF

This expression can be transformed into I = 1 3/7PNFNF or NF = I/ 1 3/7PNF. The latter expression is the
relevant consumers' demand function for non-food in the economy.

iii.)
PF F PNF NF
5 3,000 15 2,333 1/3
6 2,500 20 1,750
7 2,142 6/7 25 1,400
8 1,875 30 1,166 2/3
9 1,666 2/3 35 1,000

iv.) The answer to both questions is an affirmative. To justify this affirmation, consider the following
demand functions: F = I/3 1/3PF and NF = I/ 1 3/7PNF. Notice that using both demand functions, both food
and non-food are positively or directly related to income(I). Likewise respective prices PF and PNF will
inversely or negatively influence F and NF respectively.