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Microeconomics I

Undergraduate Programs: Business Administration and Economics

1st Semester


Professor: Catarina Reis

TAs: Duarte Stokes, Eduardo Catroga, Francisca Rebelo, Joo Guerreiro,
Ricardo Monteiro

Consumer Choice
Exercise 1.
Function U allows us to know how that agent orders different combinations of goods
x e y according to his preferences. For each of the following representations what is
the shape of the indifference curves and what is the marginal rate of substitution
(MRS)? What does that tell you about the agents preferences?
a. U

x 2y

b. U


c. U


d. U


x y
3 4

Exercise 2.

Consider the following utility functions:

a. U ( x, y)

( x y) 2

b. U (x, y)

0.2 log x 0.5log y

c. U ( x, y )


d. U ( x, y)

Compute the marginal rate of substitution (MRS) of x for y for each of the utility
functions above. For each case, analyze the evolution of the MRS along the
indifference curve. What information does the slope of the indifference curve at a
given point give you?

Exercise 3.
Suppose that you have 40 monetary units (m.u.) to spend on two goods, whose unitary
prices are p1 10 e p 2 5 .
a) Specify the budget constraint and represent it graphically.
b) If you spend all the income on good 1, how much of the good can you purchase?
And what if you spend all the income on good 2?
c) If the price of both goods varies by 10% and the income also varies by 10%, how
will the budget constraint change? How would your answer change if only the
prices varied in the same proportion?
d) Suppose that the price of good 1 increases to 20 m.u.. What is the new budget
constraint? Represent it graphically.
e) How much of good 1 can you buy if you spend all of your income in it?
f) Redo a) for a 60 m.u. income and prices p1

20 , p 2


g) Compute the intersection point between the two budget constraints.

h) Identify the area that corresponds to the bundles that you can afford after the
increase in your income and in the price of good 1, but that you could not afford
under the conditions of a). Identify the area that corresponds to the bundles that
you could afford initially but you cannot afford now. In which situation are you
better off?
Exercise 4.
Suppose that you have a certain income level and that if you spend it all on goods x
and y you can afford bundle x, y (3,8) or bundle x, y (8,3) .
a) Plot these two bundles and the budget constraint.
b) What is the price of one unit of good x? (in terms of y)
c) If you spend all of your income on good x, how many units can you afford?
d) Suppose that there is a rationing situation in which the consumption of goods x
and y is limited to 9 and 11 units respectively. Draw the budget constraint under
these conditions.
Exercise 5.
The income of a certain consumer is 120 m.u. being totally spent on goods x and y.
The price of y is 3 m.u.. The price of each unit of x is not constant, depending on the
quantity bought of that good as follows:
if 0 x 20, then the price of x is 4 m.u.;
if 20 x 40 , then the price of x is 3 m.u.;
if x 40, then the price of x is 2 m.u..
a) Represent graphically the budget constraint of this consumer
b) Suppose now that the price of the first 20 units is always 4 m.u.; for each
additional unit (after the 20th unit) the price becomes 3 m.u.; finally for each
additional unit (after the the 40th) the price decreases further to 2 m.u. Represent

graphically the budget constraint for the case that the consumers income is 180
Exercise 6.
Consider the problem of a farmer who allocates his income to consuming diesel (x)
and food (y). Knowing that small farmers spend large amounts of money on diesel,
the government decided to give them a subsidy of s per liter of diesel. This subsidy is
only given when consumption is lower than x liters of diesel.
a) Write the budget constraint before and after the government subsidy. Represent it
b) Suppose that the representative farmer consumes the bundle ( x0 , y0 ) , with x0 x .
Imagine that instead of subsidizing the price of diesel, the government gives an
equivalent monetary compensation, such that the farmer can still afford to
consume ( x0 , y0 ) . What is the new budget constraint? Represent graphically.
c) Answer question a) again, but assume that the subsidy is conceded to the
consumption of the first x liters of diesel.
Exercise 7.
Suppose that U is an utility index that ranks the consumers' preferences over the
different combinations of goods x and y:

3 x 0.5 y 0.5

Consider a consumer who has an income level of 600 m.u. and faces prices of 30 m.u
for good x and 15 m.u. for good y.
a) Represent the analytic expression for the budget constraint.
b) Determine the optimal bundle of goods for this consumer. What is the marginal
rate of substitution (MRS) in the optimal point? Interpret this result and represent
it graphically.

If you double the consumers disposable income, what will be the change in the
consumption of each of the goods and in the MRS in the optimal point? Explain
the concept behind.

d) Calculate the new optimal point and the proportion of income that the consumer
spends in each good.
Exercise 8.
Consider an individual consuming two different types of goods in a specific point.
This point is such that if he decreases the consumption of good 1 by one unit, he
needs to increase the consumption of good 2 by two units in order to maintain his
level of satisfaction (utility) (consider p1 4 e p2 1).
a) Explain, in your own words, why the consumer is not at his optimal point.
b) In which direction should the consumption of both goods vary in order to
maximize utility?

Exercise 9.
Consider a consumer who draws satisfaction from two broad types of goods: food, x1 ,
and entertainment, x 2 . His utility function is U

75 x1




. His income is 100

a) Can the consumer draw satisfaction from the consumption of a single good?
Justify. Which is the meaning of number 75 in the utility function?
b) Suppose that the consumer faces the following prices: p1 5 e p2 10 .
Determine the optimal quantities of both goods and the corresponding level of

Suppose now that the individual cannot consume more than 5 units of
entertainment. What is the new optimal solution? Will the consumer be better off
or worse off than in the initial situation? Represent it graphically.
Exercise 10.

Suppose that the preferences of a consumer can be described by the following utility

4xy 4x

This consumer has an income of 1300 m.u. and the prices of the goods x and y are 50
and 30 m.u., respectively.
a) Represent graphically the budget constraint.
Consider now that the government had decided to impose some restrictions on the
consumption of x and y:
each consumer cannot consume more than 20 units of each good;
each consumer is given 30 coupons. For each unit of x or y purchased the
consumer needs to deliver one of these coupons, and also pay its
corresponding price.
b) What is the maximum number of units of good x the consumer can buy, respecting
all the constraints?
c) Represent graphically the new consumption set of this consumer.
d) What is the selected bundle?
e) What would be the selected bundle, if the government established a lump sum tax
of 150 m.u.?
Exercise 11.
Mr. Ildio spends all his income on two goods: gasoline (x) and food (y). His
preferences can be ranked by the following utility index: U x0.5 y 0.5 .
a) Assuming that the unitary price of food is 1 m.u., the price of one unit of gasoline
is 5 m.u. and that the weekly income of this consumer is 100 m.u., find his
optimal point of consumption.
(Note: By assumption, we are considering that food 'behaves' as a composite

b) The board of the firm where Mr. Ilidio works considers him an outstanding
worker and therefore decided to give him a raise. However, in order to not
overload Mr. Ilidio taxable income, the firm decided to remunerate him (further
to the 100 m.u.) with coupons for gasoline consumption (which are personal and
not resalable). Therefore, Mr. Ilidio now earns 10 coupons per week that he can
trade for gasoline at a rate of one unit of gasoline for each coupon. What is the
new optimal point of consumption for Mr. Ilidio? Has his situation improved
relative to a)?

Mr. Ilidios good reputation continues growing exponentially and the board
decided to raise him again. Now he is paid the 100 m.u. and also given 30
coupons for gasoline (that is, 20 coupons more than in b)). What is the new
optimal point of consumption for Mr. Ilidio? If you were Mr. Ilidio how do you
would react to this proposal?

d) Suppose that Mr. Ilidio keeps receiving 30 coupons for gasoline, but that the price
of this good in the meantime decreased to 3 m.u.. What is the new optimal
consumption point? Interpret the result.
Exercise 12.
After receiving the advice of Catlica's Microeconomics students, Mr. Todosorrisos
decided to construct an Amusement Park in Brincolndia. At this moment he his
negotiating exclusive contracts with several suppliers.
For instance, he is planning to sell just one type of sodas: orangeade or coke. Mr.
Todosorrisos wants to choose the drink that maximizes revenues for the park. In the
case of equal revenues, he will choose the one that maximizes the utility of park
a) The park visitors spend 1200 m.u. in sodas per visit. The price of an orangeade is
60 m.u., the price of a coke is 50 m.u. The utility function of the visitors is given
by U 2( L 2) 0.75 (C 2) 0.25 , where L e C are the quantities of orangeades and
cokes consumed per visit. Which drink should Mr. Todosorrisos choose?
b) Once the above measure was implemented, Dr. Todomalandro decided to sell
cokes clandestinely in his carousel at a unitary price of 50 m.u. (if you have not
answered question a) assume that Mr. Todosorrisos chose to sell only orangeade).
Determine the visitors new optimal consumption point.
c) In order to oppose the clandestine activity, Mr. Todosorrisos implemented a fine
of 12,5 m.u. on each visitor that is caught drinking a coke bought from Dr.
Todomalandro. What is the new optimal consumption point?
Exercise 13.
Students holding a youth card (carto jovem) have the right to a percentage discount
in all trips made by train. Comment on the following sentences and make a
graphically analysis.
a) A student who is indifferent between buying a youth card or pay the regular ticket
price will never spend less money in train travelling if he buys the youth card.
b) The introduction of the youth card discount will never result in a reduction of the
train trips made by the student.

Exercise 14.
Joos only concern is his final average grade for the licenciatura. Joo has 30 hours
to prepare the Microeconomics and Statistics I exams. It is known that for each hour
of study of Microeconomics Joo can increase that courses grade by 0.25 points.
For Statistics I each additional hour of study results in increasing the final grade by
0.5 points. Joo has not studied anything yet, so if he dedicates zero hours to any of
the courses he will get a zero in that course.
a) Indicate a utility function that respects Joos preferences (carefully define all the
variables you use).
b) Which grades can Joo expect in those two courses?
c) Assume that if Joo allocates two hours to reviewing his classes of Principles of
Economics, he can boost his productivity on the regular study of Microeconomics
by 0.7 points for each hour of study (on top of the 0.25 points he already 'gains').
Will it be worth reviewing the classes of Principles of Economics? Illustrate your
answer graphically.
Exercise 15.
Determine the optimal solutions for the following problems:
a) U(x,y)=x+2y

1; p y

3; m

60 ;




px 1 ; py

2 ; m 60 ;



3 ; py

1 ; m 60 .

b) U ( x, y)


x y
, ; px
3 4

c) U (x, y)


y; py







d) U ( x, y)

x 3

m 10 ;


20 ;



3; m 90 .

1; m 12 .

y; p x


2; p y

1; p y


Exercise 16.
Consider a consumer whose preferences can be represented by the following utility

2 x 0.5 y 0.5

a) Find the algebraic expression of the ordinary demand function for each of the
b) Consider now that the prices of goods x and y are, 20 and 25 m.u., respectively.
Calculate the consumers optimal consumption points for the following two levels
of income: 300 and 500 m.u.
c) Assume that the consumers income is equal to 300 m.u. Obtain the expression of
the demand curve for each of the goods. Represent those curves graphically.
d) Consider the following situations:
A: px

20; py

25; m 300

B: px 12; py 15;m 300

C: px

25; py

25; m 300


Use the ordinary demand functions to calculate the bundles chosen by the
consumer in each situation.


Use the relevant demand curves to obtain the purchased quantities of good x
in situations A e C.
Exercise 17.

Consider a utility function U ( x, y )

A: px 1;py
B: p x

x 0.5 y 0.5 and the following situations:

2;m 41

1; p y

4; m


a) Find the ordinary demand functions for goods x and y.

b) Decompose the total effect on demand of good y, caused by the increase in its
price, into substitution and income effects (use the Hicks compensation criterion).
Conduct the analysis both graphically and analytically.
Exercise 18.
Joo and Antnio are two good friends who spend all their monthly allowances on
beer (good x) and cinema (good y). Both have the same preferences, which can be
summarized by the following utility function:
1 1
x y
a) Knowing that both of them receive a monthly allowance of 6000 m.u., that the
price of a cinema ticket is 500 m.u. ( p y ) and that the price of a beer is 500 m.u. (

p x ), calculate how many times they go to the cinema and how many beers they
drink each month.
b) Assume now that the price of a beer increases to 2000 m.u.. Calculate the effect
of this price increase on the number of beers consumed. Decompose this total
effect into substitution and income effects (Hicks). Illustrate graphically your

c) Due to the beer price increase, Joo and Antnio asked their parents for a raise in
their monthly allowances. Their parents accepted the requested in such a way that
they can now continue consuming the same number of beers and going to cinema
the same number of times as before. However, Joo's father forbade him to go
more times to the cinema than in the initial situation. Joo complained and
argued that due to that constraint he would lose the company of Antnio in
drinking some beers. Is Joo right? Justify your answer by making the necessary
calculus and by illustrating graphically.
d) Calculate the utility of Joo and Antnio in the case of question c) and interpret
the results.
Exercise 19.
Afonso spends all of his monthly allowance of 240 m.u. in buying two goods:
chocolates (good x) and CD's (good y). Consider that his preferences can be described
by the utility index U xy .
a) Find the demand functions for both goods. If p x
chosen bundle be?

2 and p y

5 , what will the

b) If Afonso's income increases by 1%, what will be the impact on the quantity
demanded of good y? Is this an inferior good?
c) Suppose that the price of CD's increased to 7.2 m.u.. Afonso's father decided to
compensate him for this price increase. In order to do so, the father increased
Afonso's monthly allowance in such a way that he became indifferent relative to
the initial situation. By how much has the monthly allowance increased?
d) If Afonso's father had not compensated him, how much would Afonso be willing
to pay to keep the prices unchanged (as in a))?
e) How would your answer to the previous question differ if Afonsos utility
function was instead given by U x 2 y .
(Note: Test of 04/11/2003)
Exercise 20.
Joo receives a monthly allowance of 40 from his parents to spend in fruit and
candies. His preferences for these goods can be described by the following utility
U x, y 2 xy
Where x = monthly consumption of fruit (in kg)
y = monthly consumption of candies (in kg)
Consider that Joo buys both goods at the school's bar, where a single price is
charged, per kg, for each type of good:


Situation 1
Situation 2


a) Show that the demand functions for fruit and candies are given by:

b) Using the compensation criterion la Hicks, decompose the total effect on the
demand for good x, caused by the change from situation 1 to situation 2, into
substitution effect and income effect. Illustrate your answer graphically.

c) Joo's mother was worried about his sons diet. Therefore, she forbade him to
consume more than 1.5kg of candies per month; otherwise, he would suffer a
reduction of 5 in his monthly allowance. Assume that the prices of situation 2
are currently set ( Px =5 e Py =10) and that Joo cannot lie, that is, he cannot
consume more than 1.5kg of candies and still receive a monthly allowance of 40.
Discuss, justifying, which of the following is preferable for Joo: A) restricting
his consumption of candies to 1.5kg or B) suffering a cut in his monthly
allowance. Show both alternatives graphically.
d) Pedro (Joo's brother) receives the same monthly allowance to consume the same
goods. We know, however, that he is willing to exchange one good for the other
at a constant rate of , regardless of his levels of consumption. In other words, in
order to consume an additional kg of fruit, Pedro is willing to give up of kg of
candies. Do you think that Pedro's mother also needs to worry about this sons
diet? (that is, does Pedro consume more than 1.5kg of candies per month). Justify
your answer.
Note: In this question assume the prices are those of situation 2.
(Note: Adapted from the test of 05/04/2006)

Exercise 21.
Joos preferences for lettuces (a) and onions (c) that can be translated in the
following function:

U (a, c) ac0.5
a) Determine Joo's demand functions for the two goods.
b) If the price of lettuces increases by 2% and at the same time the price of onions
decreases by 3%, what should be percentage change in Joo's optimal consumption of
lettuces and onions?
c) In a given week Joo decided to consume 20 lettuces and 10 onions. The price of
lettuce in that week was 1 m.u. per unit. Determine both the value of Joo's weekly
allowance and the price of the onions in that week.
d) Suddenly, the price of lettuces increased to 2 m.u. Joo's mother became upset
with the situation because she was very happy with her son's consumption of lettuces.
So, she decided to give him a certain number of lettuces until he could afford to

consume the same quantities of lettuces and onions as before (that is, in the previous
optimal point).

Indicate how many lettuces Joos mother gave him. Show graphically
Joos new budget constraint.

ii) Joo' s mother was even more upset after finding out that his son, even after
her generous offer, continued to consume less lettuces than in the initial
situation. Explain to his mother why did that happened.
e) Joo has a friend, Miguel. The other day, Miguel told him that, in order to keep his
utility at a constant level, he is always willing to exchange two units of onion for one
of lettuce.
Miguel's mother does not give him a weekly allowance to be spent on lettuces and
onions, but Miguel is the owner of a small farm where he plants those vegetables.
However, the different combinations of lettuces and onions that Miguel can plot on
his land are very dependent on the average temperature in degrees Celsius (g) of the
previous year (last 12 months). The set of potential combinations of those two goods
can be described by the following expression:

c (40 g )

(40 g )
(65 g )

In the beginning of 2006, Miguel told Joo that he had decided to plant only lettuces
that year.
What is the interval of average temperature (in degrees Celsius), which might
occurred in the previous year, to justify Miguels decision of planting only lettuces?
(Note: Test of 26/10/2006)

Exercise 22.
Consider a country where people just consume two goods: rice (y) and potatoes (x).
Due to producers and consumers pressures and protests, the government decided to
launch a program of taxes and subsidies on potatoes. The first 10 units are subsidized
through a specific subsidy, while consumption levels over 25 units are charged an 'advalorem' tax.
a) Draw the budget constraint before and after the introduction of this governmental
program. What is the impact of the program on consumer's welfare? Under what
circumstances can we say that the program results, for sure, in a welfare loss?
b) Suppose that a representative consumer was consuming ( x0 , y0 ) with 10 x 0 25 .
Due to the programs failure, the government decides alternatively to grant a
lump-sum subsidy on the consumers income, such that he can still afford to
consume ( x0 , y0 ) . In what circumstances can we say that the consumer has a
welfare improvement relative to the previous situation (the first program
implemented by the government)?


c) The producers also lobbied for more government support. The government,
however, decided that any subsidy to farmers should be funded by an increase in
taxation. Which of the following is the best instrument in terms of consumers
welfare: a specific tax (on good x) or a lump-sum tax on income? May the
consumer prefer the opposite to what youve just concluded?
[Note: in answering c) please ignore the previous questions]

Exercise 23.
Diogo is a teenager who lives with his family in a small village. Every month his
father gives him 84 of allowance. Diogo dreams of becoming a famous soccer
player. So, he spends all of his money in renting a soccer field (hours) and in snacks
to recover from the trainings. Assume that for each hour of practice he needs to eat
two snacks, otherwise he will not increase his utility. The renting price per hour is 3
and the price of each snack is 2.
a) What is Diogos utility function?
b) Compute the ordinary demand function for each good.
c) Determine Diogos optimal choice and represent it in a graph.
(Note: Adapted from the test of 29/06/2011)
Exercise 24.
A given agent is given a choice between 2 bundles x and y. Which of the following
violates the preferences assumptions?

I dont know.

b. They are so different, I just cant choose.


They are the same to me.

d. I dont care, just choose for me.

Exercise 25.
Cristopher wants to buy a new phone, he is comparing 3 different brands Appel,
Sangsung and Noky. When comparing 2 phones, he will prefer the phone that has a
higher score in at least 2 of the three aspects: Apps, Wifi, Coolness. The phones
scores on each characteristic are as follows:









Are his preferences transitive?

b. Consider that his decision is based on the sum of scores. Are preferences
transitive in that case?