Code: BS ECON-3103 Title: Intermediate Microeconomics

Instructor: Babar Aziz, PhD Date: Tuesday, October 31, 2023

Assignment 1
Part (I): Utility, Choices and Demand
1 If two goods are perfect substitute, what is the demand function for good 2?
2 If a consumer has a utility function u( x1 , x2 )  x1 x23 , what fraction of income will the consumer spend on
good 2?
3 Suppose the Douglas utility function u( x1 , x2 )  x1a x2b , derive the demand functions for x1 & x2 .
4 Compare Quantity tax with Lump-sum tax and comment which one is better in connection with
consumer’s well being.
5 Raising the number to an odd power was a monotonic transformation. What about raising a number to
an even power? Is this a monotonic transformation?
6 Can you explain why taking a monotonic transformation of a utility function doesn’t change the marginal
rate of substitution?
7 What kind of preferences is represented by the given utility functions? (i) u( x1 , x2 )  x1 x2 ; (ii)
u( x1 , x2 )  x1 x23 ; (iii) u( x1 , x2 )  x1  x2 : (iv) u( x1 , x2 )  min{ax1 , bx2 } : (iv) u( x1 , x2 )  k  ln x1  x2
8 What do you mean by homothetic preferences? Why perfect substitute, perfect compliment and cob
Douglas preferences are homothetic? Why not quasilinear preferences are not?
9 Highlight the relation between income offer curve and engel curve; and also between price offer curve
and demand curve.
10 Point out utility functions in case of (i) perfect substitutes, (ii) perfect complements, (iii) neutrals, and (iv)
bads. Derive demand functions in these cases as well.

Part (II): Measuring Utility

Suppose a general form of Douglas utility function is as u( x1 , x2 )  x1c x2d . After doing necessary calculation from
the given data the specific form of the function is as u( x1 , x2 )  x10.35 x20.65 . The governments have variety of tools to
generate revenue and along with subsidy policies to the consumer. Calculate the utility in case of government
actions as described from number 1 to number 7. Also compare your results with tenure 5 and comment what
happened with the overall well being of the consumers after imposition of certain decisions by the Government in
comparison with tenure 5.

Year Effects of P1 P2 m X1 X2 S1 S2 U
0 15 17 5000 83 221 0.25 0.75 173
1 15% Q-tax on good 1
2 25% Subsidy on good 2
3 25 % Lump-sum tax
4 15% QT + 25% S + 15% LS tax
5 20% QT + 15% S + 15% LS tax
6 15% QT + 15% S + 0% LS tax
7 0% QT + 15% S + 15% LS tax

1. If Government imposes 15% Quantity tax on good 1.

2. If Government gives 25% subsidy on good 2.
3. If Government imposes 25% Lump-sum tax.
4. If Government imposes 15% Quantity tax on good 1; gives 25% subsidy on good 2; and imposes 15% Lump-
sum tax as well.
5. If Government imposes 20% Quantity tax on good 1; gives 15% subsidy on good 2; and imposes 15% Lump-
sum tax as well.
6. If Government imposes 15% Quantity tax on good 1; and gives 15% subsidy on good 2.
7. If Government gives 15% subsidy on good 2; and imposes 15% Lump-sum tax.

Assignment 1
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