Econ 2316: Microeconomic Theory

Homework 1

Due Friday, September 29, 2017, at the beginning of class. Students are welcome to discuss
homework in groups, but each student must prepare and submit a unique assignment and note the
names of other group members. All assignments may be handwritten but must be neat and
professionally organized. Answer all parts of all questions, and show your work. We cannot give
partial credit (or give you feedback) if your answer is wrong and we do not know what you did.

Question 1)

Suppose demand and supply have the following equations, respectively:

= 300 6

= 60 + 2
a) What are the market-clearing price and quantity?
b) Suppose the government introduces a price ceiling of $20. What would be the quantities demanded
and supplied?

Question 2)
In 2015, Americans smoked 12.5 billion packs of cigarettes. The average retail price (including
taxes) was $5 per pack.

a) Suppose that at that price and quantity, the price elasticity of demand is -0.5, and the price
elasticity of supply is 0.4. Also suppose the demand and supply curves are both linear. Using the
above information, derive the demand and supply curves for the cigarette market in the US in 2015.
Hint: demand is given by = , and supply is given by = + . We know that =
= 12.5 (billion packs), that = 5, and we know the elasticities (and their formulas). Solve for
, , , and .

b) Back in 1998, Americans smoked 23.5 billion packs of cigarettes, and the retail price was about
$2.00. Suppose all of the decrease in cigarette consumption is due to the price increase. What might
you deduce from that about the price elasticity of demand (using the midpoint formula)?

c) The elasticity you calculated in part (b) is not necessarily the true price elasticity of demand
because demand may have shifted for other reasons. What else could have affected cigarette
consumption between 1998 and 2010?
Question 3)

a) John has preferences for two goods: fruit and ice cream. Let fruit be on the horizontal (x) axis,
and draw ice cream on the vertical (y) axis. Plot and label the following bundles.

A (1 fruit, 9 ice cream)

B (7 fruit, 3 ice cream)

C (0 fruit, 4 ice cream)

D (8 fruit, 8 ice cream)

E (4 fruit, 6 ice cream)

b) Johns preferences satisfy assumptions 1 through 4 as discussed in class, and he is indifferent

between point A and point B. List all five points in descending order of preference, using (>) to
denote strict preference and (~) to denote indifference. (Note: the information given is enough to
determine the order with certainty.)

Question 4)
Paul considers apple juice () and guava juice () to be perfect substitutes (he is indifferent
between consuming 3 glasses of apple juice and consuming 2 glasses of guava juice). His utility
function is therefore given by:

(, ) = 2 + 3

a) Paul has $18 to spend on juice. The price of apple juice and guava juice is constant at $3 per
glass. Draw Pauls budget constraint, keeping apple juice on the x-axis and guava juice on the y-axis.

b) What is Pauls utility-maximizing bundle of apple juice and guava juice subject to his budget
constraint?

c) Now suppose that the supermarket changes its pricing strategy for apple juice by offering a
quantity discount. Apple juice still costs $3 per glass for the first 2 glasses, but every additional glass
of apple juice only costs $1. Paul still has $18 to spend, and the price of guava juice remains at $3
per glass. Draw Pauls new budget constraint.

d) What is Pauls optimal bundle of apple juice and guava juice now?
Question 5)

Ringo has the following utility function:

(, ) = + ,

where is his consumption of candy bars, with = $2, and is coffee, with = $2.

a) Assume that his income is $100. How many candy bars and how much coffee will Ringo
consume?

b) Suppose the price of candy bars decreases from $2 to $1. What is the total effect of the price
increase on Ringos consumption of candy bars?

c) What is the substitution effect on Ringos consumption of candy bars? What is the income effect?