Econ 21

Prof. Doyle

Problem Set 2: Consumer Theory

Question 1. Chapter 3, Problem 1. Substituting for y with y(x)the implicit functionmakes
solving this problem easier.
Question 2. Chapter 3, Problem 3. Here, lets not focus on diminishing MRS again (see above).
Consider each function in this problem. Show that they all have the same MRS, but the marginal
utilities of x and y look quite different. This is good practice for taking partials.
Question 3.

Chapter 3, Problem 5.

Question 4.

Chapter 3, Problem 7.

Question 5. For each of the following expressions, state the formal assumption that you think is
being made about the individuals utility function:
(a) Margarine is just as good as the high-priced alternative, butter.
(b) Peanut butter and jelly go together like a horse and carriage.
(c) Things go better with Coke.
(d) Popcorn is addictive: the more you eat, the more you want.
(e) Mosquitoes ruin a nice day at the beach.
Question 6. Al derives utility from three goods: music (m), wine (w), and cheese (c). His utility
function is of the simple linear form
U (m, w, c) = m + 2w + 3c.
(a) Assuming Als consumption of music is fixed at 10, determine the equations for the indifference
curves for w and c where U = 40 and where U = 70. Sketch these curves.
(b) Show that Als MRS of wine for cheese is constant for all values of w and c on the indifference
curves calculated in part (a).
(c) Suppose Als consumption of music increases to 20. How would this change your answers to
parts (a) and (b)? Explain your results intuitively.

Problem Set 2

Econ 21

Question 7.

Suppose the utility function for two goods x and y has the Cobb-Douglas form

U (x, y) = xy.

(a) Graph the U = 10 indifference curve associated with this utility function.
(b) If x = 5, what must y equal to be on the U = 10 indifference curve? What is the M RS at
this point?
(c) In general, develop an expression for the MRS for this utility function. Show how this can
be interpreted as the ratio of the marginal utilities for x and y.
Question 8.

Chapter 4, Problem 1.

Question 9.

Chapter 4, Problem 2.

Question 10.

Chapter 4, Problem 7.

Question 11. In Example 4.3, the textbook used a specific indirect utility function to illustrate
the lump sum principle that an income tax reduces utility to a lesser extent than a sales tax that
garners the same revenue. Here you are asked to do the following.
(a) Show this result graphically for a two-good case by showing the budget constraints that must
prevail under each tax. (Hint: First draw the sales tax case. Then show that the budget
constraint for an income tax that collects the same revenue must pass through the point
chosen under the sales tax but will offer options preferable to the individual.)
(b) Show that if an individual consumers the two goods in fixed proportions, the lump sum
principle does not hold because both taxes reduce utility by the same amount.
(c) Discuss whether the lump sum principle holds for the many-good case, too.
Question 12. Suppose a consumers utility function is given by u(x, y) = ln x + ln y. Solve the
expenditure minimization problem:
min px x + py y
subject to
u(x, y) = u
.
Show that
r

py u
e
px
r
px u

y (px , py , u
) =
e .
py

x (px , py , u
) =

Problem Set 2

Econ 21

Show, finally, that the expenditure function can be written

p
E(px, py , u
) = 2 px py eu .

It may be useful to note the following two mathematical relations involving natural logs and the
exponential function: ln a + ln b = ln(ab) and eln a = a.
Question 13. (optional) For advanced students who are looking for additional interesting
applications of our early development of consumer theory, here is an optional problem: Chapter 4,
Problem 4.14.