EC 203 - INTERMEDIATE MICROECONOMICS

Boğaziçi University - Department of Economics

Fall 2019
Problem Set 3

1. Leo consumes only nuts and berries. Fortunately, he likes both goods. The consumption bundle where
Leo consumes x1 units of nuts per week and x2 units of berries per week is written as (x1 , x2 ).

(a) The set of consumption bundles (x1 , x2 ) such that Leo is indifferent between (x1 , x2 ) and (16, 4) is
√
the set of bundles such that x1 ≥ 0, x2 ≥ 0, and x2 = 20 − 4 x1 . Plot several points that lie on the
indifference curve that passes through the point (16, 4) and sketch this curve.
√
(b) In fact, Leo’s preferences can be represented by the utility function u(x1 , x2 ) = 4 x1 + x2 . The
price for nuts is $1 per unit and the price for berries is $2 per unit. Leo has $24 to spend on the
two goods. Write down Leo’s budget constraint and solve for his optimal consumption bundle.
(c) Now Leo has $10 more to spend on the two goods ($34 in total), and what is his optimal consumption
bundle now? Compare your solution with the previous one. Can you say anything interesting?
(d) Now Leo has only $9 in total to spend. Is he still able to consume the same amount of nuts as in
part b? Explain.

2. Leo’s birthday is coming up and all he has in his possession is one bottle of soda. His friends get together
and decide to buy him a gift. They agree on getting him some bottles of soda (s) and some fancy colorful
soda making powder/shaker contraptions (f ). Leo’s utility function is given by U (s, f ) = s + f s − f 2 .
The soda costs ps = 1 and the powder shaker contraptions cost pf = 2. His friends decide to buy him
two bottles of soda (in addition to the one he already has) and one powder shaker thing, spending a
total of $4. (Throughout this question, you can assume that both soda and the fancy powder things can
be consumed in any fractional amount. When drawing diagrams, put soda on the horizontal axis and
the powder shaker things on the vertical axis. Also, you should only be concerned about the negatively
sloped portions of the indifference curves. Do not worry about portions which are positively sloped.)

(a) At Leo’s initial position prior to receiving the gifts, is he optimized?

(b) What is Leo’s utility level before (U0 ) and after (U1 ) the gifts?
(c) Could Leo’s friends have spent their money more wisely in terms of making Leo happier? Explain.
If so, what would have been a better way to spend the $4?

3. Leo consumes only goods 1 and 2. Their prices are p1 and p2 , respectively, and we let p = (p1 , p2 ). Leo’s
√
income is m. His utility function is u(x) = x1 + x2 .

(a) Suppose p1 = 1. Find the general form of his demand functions xL L

1 (1, p2 , m) and x2 (1, p2 , m), which
solve the problem
max u(x1 , x2 ) subject to 1 · x1 + p2 · x2 = m
x1 ,x2 ≥0

1
 (b) Now find the demand functions for a general price vector (p1 , p2 ). (Hint: Use the homogeneity
property of the demand: for any α > 0 and prices and income, (p1 , p2 , m), we have xL (p1 , p2 , m) =
xL (αp1 , αp2 , αm), that is, when all prices and income change proportionately the demand does
not change. This is because the budget set does not change when all prices and income change
proportionately, as we have discussed in class.)
(c) Find the marginal utility of income in terms of prices and income.

4. For each of the following utility functions below, for good 1, derive and draw the Engel curve, x1 (m),
and the demand curve, x1 (p1 ).
1/3 2/3
(a) u(x1 , x2 ) = x1 x2
(b) u(x1 , x2 ) = x21 + x22
(c) u(x1 , x2 ) = 2x1 + 3x2
1/2
(d) u(x1 , x2 ) = x1 + 2x2

5. Determine in the following scenarios whether the good in question is a normal good for sure, an inferior
good for sure, or whether one cannot tell from the information given.

(a) When Alex was a graduate student with very low income at Boston U, he always ate burritos from a
food truck for lunch. Now Alex has graduated and has a well-paying job in Toronto, where burritos
from food trucks are cheaper than they were in Boston. Alex eats far fewer burritos now even though
he has just as much time for lunch, his preferences haven’t changed, the burritos are just as good
and the lunch alternatives are more or less the same. For Alex, what kind of good are food truck
burritos?
(b) In his grad student days, Alex hardly ever bought himself a lemonade, let alone buying lemonade for
others. Now, when he comes back to visit Boston, it’s quite possible to see him buy entire rounds
of lemonades, even for strangers. The price of lemonade in Boston has not changed, nor have Alex’s
preferences. For Alex, what kind of good is lemonade?
(c) Since Alex got his job in Toronto, the Canadian dollar (the currency in which Alex is paid his salary)
has been becoming increasingly more valuable relative to the U.S. dollar. Because Alex visits the
U.S. quite often, it is as easy for him to shop for clothes in either country. Lately, he has been doing
more and more of his clothes shopping in the U.S. The price tags have not changed in either country,
and the clothes Alex buys are the same kind in both countries. For Alex, what kind of good are
clothes?