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EC202: Intermediate Microeconomics

Semester 1, 2023
Tutorial 3 Solution (Week 4)
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1. How does a price consumption curve differ from an income consumption curve?
The price consumption curve plots the set of optimal bundles for two goods as the
price of one good changes while the price of the other good and income remain
constant. The income consumption curve, on the other hand, plots the set of optimal
bundles for two goods as the consumer’s income changes while holding the prices of
both goods constant.

2. Suppose a consumer purchases only three goods, food, clothing, and shelter. Could all three
goods be normal? Could all three goods be inferior? Explain.

If the consumer purchases only three goods and income increases, it is possible that
consumption of all three goods will increase. For example, the consumer might
allocate one-third of the increase to each of the three goods. Thus, it is possible for
all three goods to be normal. If the consumer purchases only three goods and income
increases, it is not possible that consumption of all three goods will decrease. Recall
that if consumption falls when income increases the good is inferior. If this were to
occur, the consumer would be spending less income than he did prior to the income
increase. Thus, it is not possible for all three goods to be inferior.

3. Why might an individual supply less labor (demand more leisure) as the wage rate rises?
When the wage rate rises, the substitution effect will induce a worker to supply more
hours of labor. The income effect, on the other hand, may induce the worker to
increase the amount of leisure and decrease the amount of labor. If the income effect
reduces the amount of labor supplied more than the substitution effect increases it,
the worker will ultimately supply less hours of labor.

4. Carlos has a utility function that depends on the number of musicals and the number of operas
seeneach month. His utility function is given by U = xy2, where x is the number of movies
seen per month and y is the number of operas seen per month. The corresponding marginal
utilities are given by: MUx = y2 and MUy = 2xy.

a) Does Carlos believe that more is better for each good?

By plugging in ever higher numerical values of x and ever higher numerical

valuesof y, it can be verified that Carlos’ utility goes up whenever x or y
increases.
 b) Does Carlos have a diminishing marginal utility for each good?

First, consider the marginal utility of x, MUx. Since x does not appear anywhere in
the formula for MUx, MUx is independent of x. Hence, the marginal utility of movies
is independent of the number of movies seen, and so the marginal utility of movies
does not decrease as the number of movies increases. Next, consider the marginal
utility of y, MUy. Notice that MUy is an increasing function of y. Hence, the marginal
utility of operas does not decrease in the number of operas seen. In this case, neither
good, movies or operas, exhibits diminishing marginal utility.

5. Adam likes his café latte prepared to contain exactly 1/3 espresso and 2/3 steamed milk by
volume.On a graph with the volume of steamed milk on the horizontal axis and the volume of
espresso onthe vertical axis, draw two of his indifference curves, U1 and U2, with U1 > U2.

Volume
of
Espresso
3

U2
2

U1
1

1 2 3 4 5 6 Volume of
Steamed Milk

6. Pedro is a college student who receives a monthly spending from his parents of $1,000. He
uses this spending to pay rent for housing and to go to the movies (you can assume that all of
Pedro’s other expenses, such as food and clothing have already been paid for). In the town
where Pedro goes to college, each square foot of rental housing costs $2 per month. The price
of a movie ticket is $10 per ticket. Let x denote the square feet of housing, and let y denote the
number of movie tickets he purchases per month.

a) What is the expression for Pedro’s budget constraint?

2x + 10y ≤ 1000 or 2x + 10y = 1000
b) Draw a graph of Pedro’s budget line.

c) What is the maximum number of square feet of housing he can purchase given his monthly
stipend?
The maximum amount of housing Pedro can purchase is his budget divided by the
price of housing: $1,000/$2 per square feet = 500 square feet.

d) What is the maximum number of movie tickets he can purchase given his monthly stipend?
The maximum number of movie tickets Pedro can purchase is his budget divided by
the price of a movie ticket: $1,000/$10 per tickets = 100 tickets.

e) Suppose Pedro’s parents increase his stipend by 10 percent. At the same time, suppose that
in the college town he lives in, all prices, including housing rental rates and movie ticket
prices, increase by 10 percent. What happens to the graph of Pedro’s budget line?

His budget line does not change at all.

Initially, the budget line (with x on the horizontal axis and y on the vertical axis) has
a horizontal intercept equal to 1000/2 = 500 and a vertical intercept equal to 1000/10
= 100. The slope of the budget line is -2/10 = - 0.20 (the price of housing divided by
the price of movie tickets).
With the increase in Pedro’s stipend and the increases in prices we have:
• Horizontal intercept of budget line: 1000(1.10)/(2(1.10)) = 500
• Vertical intercept of budget line: 1000(1.10)/(10(1.10)) = 100
• Slope of budget line: -2(1.10)/(10(1.10)) = - 0.20.
These are the same as before and thus the budget line does not change

***The End**