Practice Assignment for Mid-Terms

1. Bobs utility function over good X and Y is U(X,Y)=10X+5Y. His income is 100 and the
price of X is 2 and price of Y is 5.

(a) Calculate the marginal rate of substitution (MRS) between X and Y.

(b) How much of X and Y will Bob buy ?

2. Ann consumes two goods X and Y, his utility function is U(X,Y)=2XY 2 . Suppose the
price of X is 10, while the price of Y is 15. Anns income is 500.

(a) Write the expression for indifference curve when Ann gets utility level 40. And along the
indifference curve you found, calculate out the numbers of consumption of X when Y=4.

(b) Write the expression for Anns budget constraint, graph the budget constraint and deter-
mine its slope.

(c) Determine the X, Y combination which maximizes Anns utility, given her budget constraint.
And figure out whats marginal rate of substitution (MRS) between two goods at that maximi-
zation point.

(d) Suppose now the price of X is changed to 15, calulate the impact on Anns optimum
choice. Whats the change to her maximized utility ?

3. Suppose the demand for the IBM personal computer is : Qd = 2400 4p

(a) At what price is the price elasticity of demand equal to zero ?

(b) When the price elasticity of demand equal to 1, whats the quantity being demand at
that point ?

(c) Figure out at what price, the price elasticity of demand is infinite, and explain what does
infinite price elasticity of demand mean ?

(d) What is the change of revenue generated by sale when the price elasticity of demand falls
from infinite to 1.

4. There are 100 consumers in the economy. Half of them belong to tribe A and demand
oranges according to the individual inverse demand curve P = 10 - 2Q. The other half belong
to tribe B and demand oranges according to the individual inverse demand curve P = 16 - 4Q.
Suppose that the market-clearing price for oranges is $4.

(a) At the market-clearing price, how many oranges does each member of tribe A buy ? What
is the price elasticity of demand by a member of tribe A at this point ?

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 (b) At the market-clearing price, how many oranges does each member of tribe B buy ? What
is the price elasticity of demand by a member of tribe B at this point ?

(c) What is the market demand for oranges in this economy ? Is the market demand function
linear ? If not, where is the kink ?

(d) Using the market demand function derived in part c., what is the total quantity of oranges
demanded in this economy at the market-clearing price ? (Hint : check that this is consistent with
your answers to parts a. and b.) What is the price elasticity of market demand at this point ? Is
the absolute value of the price elasticity of market demand larger than the absolute value of the
price elasticity of individual demand ?

(e) If the price increases from $4 to $10, how does the consumer surplus chage ? Graph the
demand curve with quantity on the horizontal axis and price on the vertical axis, and show the
change in consumer surplus.

5. Green Giant Inc. is willing to hire anybody to work in its fields and grow beans for a wage
of $10 per hour. Luke has his own farm where he grows beans with droids and labor. Droid
services cost $10 per hour.

The production function is : q = F(K,L)= KL, where K represents droid hours and L
represents Lukes own labor in hours.

(a) Assume Luke decides to produce q = 10000. How much labor and capital will he employ ?

(b) Assume that in the short run, Luke has already paid for 10, 000 hours of droid services.
Find the total cost, average cost and marginal cost functions (in terms of output q).

(c) With the same assumptions as in the previous question, suppose that the market price
for beans is equal to $100. Find Lukes farms short-run bean output. Is there a bean price low
enough so that Luke will stop producing in the short run ? If so, find it. Do the same for the long
run.

(d) Without doing any computation, describe the shapes of the long run average and marginal
cost curves. How do they relate to each other ?

6. There is a single production technology available to firms that might choose to operate in
the market for hammers. The cost function associated with this technology is given by C(q) =
3 + 3q 2 , for any q > 0, but the costs of production are equal to zero if q = 0. That is C(0) = 0.
Find the average cost and marginal cost functions.