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# Microeconomics: Theory and Applications with Calculus (Perloff)

Chapter 3

3.1

Preferences
1)

A)

B)

C)

D)

A
Topic:

Preferences

2)

A)

1
B)

C)

D)

## all preferences conditions are met.

A
Topic:

Preferences

3)

If a consumer prefers Apples to Bananas and prefers Bananas to Citrus Fruit, in order to satisfy
assumptions about preferences she has to prefer
A)

Bananas to Apples.
B)

C)

D)

## Citrus Fruit to Apples.

C
Topic:

Preferences

4)

2
The principle that "More is better" results in indifference curves
A)

sloping down.
B)

not intersecting.
C)

reflecting greater preferences the further they are from the origin.
D)

D
Topic:

Preferences

5)

A)

transitivity.
B)

completeness.
C)

rationality.
D)

nonsatiation.

B
Topic:

3
Preferences

4
6)

A)

completeness.
B)

transitivity.
C)

more is better.
D)

## All of the above.

C
Topic:

Preferences

7)

If two indifference curves were to intersect at a point, this would violate the assumption of
A)

transitivity.
B)

completeness.
C)

D)

5
A
Topic:

Preferences

8)

A)

B)

C)

D)

## none of the assumptions.

B
Topic:

Preferences

9)

A consumer's willingness to trade one good for another can be expressed by the consumer's
A)

indifference curve.
B)

C)

## Both A and B above.

D)

6
None of the above.

C
Topic:

Preferences

10)

## Convexity of indifference curves implies that consumers are willing to

A)

give up more "y" to get an extra "x" the more "x" they have.
B)

give up more "y" to get an extra "x" the less "x" they have.
C)

## settle for less of both "x" and "y".

D)

acquire more "x" only if they do not have to give up any "y".

B
Topic:

Preferences

11)

Measuring "y" on the vertical axis and "x" on the horizontal axis, convexity of indifference curves implies
that the MRS of "y" for "x"
A)

B)

## is increasing as "x" increases.

C)

7
is constant as "x" increases.
D)

A
Topic:

Preferences

12)

A)

cross.
B)

are convex.
C)

D)

## become flatter as we move down and to the right.

D
Topic:

Preferences

13)

For which of the following pairs of goods would most people likely have convex indifference curves?
A)

8
B)

C)

D)

## None of the above.

C
Topic:

Preferences

14)

If two goods are perfect substitutes, then the indifference curves for those two goods would be
A)

B)

C)

## downward sloping and straight.

D)

L-shaped.

C
Topic:

Preferences

15)
The indifference curves for left shoes and right shoes would most likely be

9
A)

B)

C)

D)

L-shaped.

D
Topic:

Preferences

10
16)

## Indifference curves cannot intersect.

True. As seen in the above figure, points a and c are on the same indifference curve and are therefore
equally preferred. Points b and c are also on the same indifference curve and are therefore equally
preferred. Transitivity implies that the consumer would be indifferent between a and b; however, since
more is preferred to less, a is preferred to b. Thus as a result of the assumption of transitivity and the
assumption that more is preferred to less, indifference curves cannot intersect.
Topic:

Preferences

17)

## Indifference curves cannot ever be concave for two goods.

False. While indifference curves are typically convex, they can be concave. This means, however, that the
MRS of y for x increases as x increases. That is, the consumer places greater value on the next x the more x
she has. The interpretation is that a consumer with concave indifference curves prefers to specialize in
either x or y but not have a mix of both.
Topic:

11
Preferences

18)

Indifference curves for perfect substitutes must be parallel lines with a slope of negative one.

False. Indifference curves for perfect substitutes are parallel lines, but the slope is not necessarily negative
one.
Topic:

Preferences

19)

Indifference curves on the same indifference map can have different shapes.

True. Indifference curves can meet all the necessary requirements and still have different shapes.
Topic:

Preferences

20)

Lisa views pizzas and burritos as goods. If she prefers a bundle of four burritos and four pizzas to a
bundle of four burritos and five pizzas, which property of consumer preference is violated? What change
in the assumptions could lead a rational consumer to prefer the first bundle?

The property of more-is-better is violated. However, if pizza is a bad, then a rational consumer would
prefer the first bundle.
Topic:

Preferences

21)

## Explain why most indifference curves are convex.

12
Diminishing marginal rates of substitution make most indifference curves convex. When people have a
lot of one good, they are willing to give up a relatively larger amount of it to get a good of which they
have relatively little.
Topic:

Preferences

13
22)

Draw the indifference curves for rock concerts and food for each of the following:

## (a) a typical 17-year-old

(b) a typical 75-year-old

See the above figure. These graphs assume that a typical 17-year-old would enjoy both food and rock
concerts. The 75-year-old might find the rock concerts neutral or even bad.
Topic:

Preferences

14
23)

Draw the indifference curves for nickels and dimes. Would they ever have a non-constant slope? Explain.

See the above figure. Two nickels are worth 1 dime. Yet for extremely large amounts of money, people
might prefer dimes to nickels for carrying purposes. That is why people often pay with exact change or
don't like to break a twenty.
Topic:

Preferences

3.2

Utility
1)

A)

15
B)

C)

D)

B
Topic:

Utility

2)

A)

## the consumer derives the same level of utility from each.

B)

the consumer derives the same level of ordinal utility from each but not the same level of cardinal utility.
C)

no comparison can be made between the two bundles since utility cannot really be measured.
D)

## the MRS between the two bundles equals one.

A
Topic:

Utility

3)

16
If the utility function (U) between food (F) and clothing (C) can be represented as U = FxC , the
marginal utility of food equals
A)

F/C .
B)

C/F .
C)

1/2 C/F .
D)

1/2 F/C .

C
Topic:

Utility

4)

If the utility function (U) between food (F) and clothing (C) can be represented as U = FxC , the
marginal utility of food
A)

is not positive.
B)

C)

D)

## increases as one obtains more clothing.

17
D
Topic:

Utility

5)

If the utility function (U) between food (F) and clothing (C) can be represented as U = FxC , the
marginal rate of substitution of clothing for food equals
A)

-C/F.
B)

-F/C.
C)

- C/F .
D)

- F/C .

A
Topic:

Utility

6)

If Fred's marginal utility of pizza equals 10 and his marginal utility of salad equals 2, then
A)

B)

C)

18
D)

## he will eat five times as much salad as pizza.

B
Topic:

Utility

7)

If Fred's marginal rate of substitution of salad for pizza equals five, then
A)

B)

C)

D)

## he will eat five times as much salad as pizza.

B
Topic:

Utility

19
8)

Adrian's total utilities of two consumption bundles are 50 and 100. This implies that
A)

B)

C)

D)

## the consumer likes the first bundle twice as much.

B
Topic:

Utility

9)

If Fred's marginal utility of pizza equals 10 and his marginal utility of salad equals 2, then we know that
A)

B)

C)

D)

## his indifference curves are downward sloping.

20
D
Topic:

Utility

10)

If the utility for two goods "x" and "y" is measured as U = x + y, then it can be concluded that
A)

B)

C)

D)

## the indifference curves on the x,y graph will be upward sloping.

A
Topic:

Utility

11)

If the utility for two goods "x" and "y" can be measured as U = x, then it can be concluded that
A)

## "x" and "y" are perfect complements.

B)

C)

the indifference curves on the x,y graph are upward sloping where "x" is measured on the horizontal axis.
D)

21
the indifference curves on the x,y graph are vertical where "x" is measured on the horizontal axis.

D
Topic:

Utility

12)

If the utility for two goods "x" and "y" can be measured as U = y, then it can be concluded that
A)

## "x" and "y" are perfect complements.

B)

C)

the indifference curves on the x,y graph are upward sloping where "x" is measured on the horizontal axis.
D)

the indifference curves on the x,y graph are horizontal where "x" is measured on the horizontal axis.

D
Topic:

Utility

22
13)

If two goods, "x" and "y", are perfect substitutes, then which of the following best represents the utility
function for the two goods?
A)

U=x+y
B)

U=x∗y
C)

2 2
U=x +y
D)

## Any of the above.

A
Topic:

Utility

14)

If Johnny likes homework (H) but hates exercise (E), which of the following might best represent his
utility function for homework and exercise?
A)

U=H+E
B)

U = H/E
C)

2
U=H + E
D)

2
U=H × E

23
B
Topic:

Utility

15)

Clifford lives by the motto "Eat, drink and be merry today, for tomorrow doesn't matter." If today's
consumption is measured on the horizontal axis and tomorrow's consumption is measured on the vertical
axis, Clifford's indifference curves
A)

B)

C)

D)

## cannot be determined from the information given.

B
Topic:

Utility

16)

Clifford lives by the motto "Eat drink and be merry today, for tomorrow doesn't matter." If today's
consumption is represented by "x" and tomorrow's consumption is represented by "y", then which of the
following best represents Clifford's utility function?
A)

U=x-y
B)

U = x/y
C)

24
U=x
D)

U=y

C
Topic:

Utility

17)

The absolute value of the slope of an indifference curve equals the ratio of the marginal utilities of the two
goods involved.

True. The MRS can be represented as the ratio of both those quantities.
Topic:

Utility

25
18)

## What is the difference between ordinal and cardinal measurement?

Prices are measured in money, which is a cardinal measure. When you have \$100 you are twice as well
off compared to having \$50. With an ordinal measure like an exam grade you can say that an A is better
than a B but not how much better it is.
Topic:

Utility

19)

Suppose Joe's utility for lobster (L) and soda (S) can be represented as U = L0.5 S0.5. Draw the
indifference curve that yields a utility level of 9. Calculate the MUL, MUS, and MRS of L for S on that
indifference curve when S = 3.

## See the above figure. Along that indifference curve, when:

0.5
S = 3, L = 27. MUL = 0.5 ∗ (S/L) = 1/6.
0.5
MUS = 0.5 ∗ (L/S) = 1.5.

26
MRS = - MUS / MUL = -9.
Joe is willing to give up nine lobsters to get another soda.
Topic:

Utility

20)

Paul has the utility function U(q1,q2)=q1q2. If Paul consumes q1=4 and q2=2 his Marginal Rate of
Substitution is
A)

-2
B)

1
C)

-1
D)

-1/2

A
Topic:

Utility

21)

Sarah has the utility function U(X,Y)=X.5Y.25. When Sarah consumes X=2 and Y=6 she has a marginal
rate of substitution of
A)

-12
B)

-1/6
C)

27
-6
D)

-1/12

A
Topic:

Utility

22)

Teddy has preferences given by the utility function U(K,L)=2L+K where K=pounds of Kale per month
and L=pounds of lettuce per month. What is Teddy's Marginal Utility of Kale? What is Teddy's
Marginal Utility from Lettuce? If Kale is on the horizontal axis, what is Teddy's marginal Rate of
Substitution?

The marginal utility of Kale is the partial derivative of the utility function with respect to K: MU K=1. For
lettuce, the marginal utility is MUL=2. The marginal rate of substitution is the ratio of marginal utilities:
MRS= -MUK/MUL= -1/2.
Topic:

Utility

23)

Amanda consumes only two goods, X and Y. Her indifference curves satisfy the four standard
assumptions. True or False: If she is indifferent between bundles (1,3) and (3,1), then bundle (2,2) must be
strictly preferred.

True. Convexity implies that for any two bundles a consumer is indifferent to, any bundle that is a convex
combination of the two is strictly preferred. (2,2) = 1/2 (3,1) + 1.2 (1,3)

28
Topic:

Utility

29
24)

A friend whom you are studying with for this class has drawn three sets of indifference curves. Explain
what he has done wrong on each graph and what assumption of preferences is violated by each
particular graph.

## (a) (b) (c)

The first has portions that are upward instead of downward sloping, which implies a consumer can
consume so much of Y that they are actually made worse off from more units (satiation). Thus this
violates the assumption that more is better.The second graph violates convexity since the curves are
bowed outward instead of inward towards the origin. The last graph violates transitivity since the
indifference curves are intersecting one another. If they cross, then all points on both indifference curves
are equally preferred. But then points exist which are on the same indifference curve but contain less of
each good.
Topic:

Utility

25)

Ed has the utility function U(F,M)= CM , where C = number of comic books per month and
M=number of movies per month. Gloria has the utility function V(F,M)=15+ CM . Do Ed and Gloria
have the same preference ordering of comics and movies? How can you tell?

Yes, they do. Gloria's utility function is an increasing monotonic transformation of Ed's preferences.
Therefore, if U(X1,Y1)>U(X2,Y2), then it must be that V(X1,Y1)>V(X2,Y2).
Topic:

Utility

26)

30
Compute the MRS for the following Utility functions:
(a) U(X,Y) = aln(X)+bln(Y), (b) U(X,Y)=XaYb, and (c) U(X,Y)=aX+bY, where a and b are strictly
positive constants.

## (a) MUX= a/X, MUY=b/Y, thus MRS=MUX/MUY=aY/bX.

(b) MUX= aYbXa-1, MUY=bXaYb-1, thus MRS=MUX/MUY=aY/bX.
(c) MUX= a, MUY=b, thus MRS=MUX/MUY=a/b.
Topic:

Utility

31
3.3

Budget Constraint
1)

Joe's income is \$500, the price of food (F) is \$2 per unit, and the price of shelter (S) is \$100. Which of the
following represents his budget constraint?
A)

500 = 2F + 100S
B)

F = 250 - 50S
C)

S = 5 - .02F
D)

## All of the above.

D
Topic:

Budget Constraint

2)

Joe's income is \$500, the price of food (F) is \$2 per unit, and the price of shelter (S) is \$100. Which of the
following represents his marginal rate of transformation of food for shelter?
A)

-5
B)

-50
C)

-.02

32
D)

## None of the above.

B
Topic:

Budget Constraint

3)

Joe's income is \$500, the price of food (F) is \$2 per unit, and the price of shelter (S) is \$100. Which of the
following represents his budget constraint?
A)

500 = 100F + 2S
B)

500 = 2F + 100S
C)

S = 500 - 2F
D)

## All of the above.

B
Topic:

Budget Constraint

4)

Joe's budget constraint equals 500 = 2F + 100S, where \$500 is Joe's income, \$2 is the price of food (F) and
\$100 is the price of shelter (S). How much food can Joe buy if he buys one unit of shelter?
A)

two units

33
B)

200 units
C)

250 units
D)

400 units

B
Topic:

Budget Constraint

5)

Joe's income is \$500, the price of food (F) is \$2, and the price of shelter (S) is \$100. Which of the following
bundles is in Joe's opportunity set?
A)

B)

C)

D)

## 150 units of food, three units of shelter

C
Topic:

Budget Constraint

6)

34
The marginal rate of transformation of y for x represents
A)

## the slope of the budget constraint.

B)

the rate at which the consumer must give up y to get one more x.
C)

- Px/ Py.
D)

## All of the above.

D
Topic:

Budget Constraint

7)

A)

## the slope of the budget constraint.

B)

the rate at which the consumer must give up x to get one more y.
C)

- Px/ Py.
D)

## All of the above.

35
Topic:

Budget Constraint

8)

The rate at which a consumer must give up y to get one more x is equal to
A)

- Px/ Py.
B)

- Px/ Py
C)

- MUx/MUy.
D)

- MUx/MUy.

A
Topic:

Budget Constraint

9)

Betty consumes good x and good y. If the price of x = \$3 and the price of y = \$4, then
A)

B)

C)

## an extra unit of x costs 3/4 units of y.

D)

36
Both B and C.

D
Topic:

Budget Constraint

10)

If the price of one good increases while the price of the other good and the consumer's income remain
unchanged, what will happen to the budget line?
A)

The budget line rotates inward from the intercept on the axis of the good that did not change in price.
B)

The budget line rotates outward from the intercept on the axis of the good that did not change in price.
C)

D)

## The budget line shifts outward without a change in slope.

A
Topic:

Budget Constraint

37
11)

Lisa eats both pizzas and burritos. If the price of a pizza increases, Lisa's opportunity set
A)

becomes larger.
B)

becomes smaller.
C)

is unchanged.
D)

B
Topic:

Budget Constraint

12)

If the consumer's income increases while the prices of both goods remain unchanged, what will happen
to the budget line?
A)

The budget line rotates inward from the intercept on the horizontal axis.
B)

The budget line rotates outward from the intercept on the vertical axis.
C)

D)

## The budget line shifts outward without a change in slope.

38
D
Topic:

Budget Constraint

13)

If the prices of both goods and income increase by the same percentage, what will happen to the budget
line?
A)

The budget line rotates inward from the intercept on the axis of the good that did not change in price.
B)

The budget line rotates outward from the intercept on the axis of the good that did not change in price.
C)

## The budget line shifts outward without a change in slope.

D)

Nothing.

D
Topic:

Budget Constraint

14)

A consumer buys food (F) and shelter (S). If the consumer's income rises and there is no change in the
prices of F or S, the marginal rate of transformation of F for S will
A)

increase.
B)

decrease.
C)

39
D)

## change, but there is not enough information to know how.

C
Topic:

Budget Constraint

15)

A)

B)

C)

D)

## budget constraint will shift outward in a parallel fashion.

B
Topic:

Budget Constraint

40
16)

A)

B)

C)

D)

## budget constraint will shift outward in a parallel fashion.

D
Topic:

Budget Constraint

17)

If a consumer's budget line for food (F) and shelter (S) is represented as F = 250 - 5S, we know that
A)

B)

C)

D)

## All of the above.

41
C
Topic:

Budget Constraint

18)

The slope of the budget line represents the rate at which the consumer is willing to trade one good for
another at any given bundle.

False. This describes the slope of the indifference curve. The slope of the budget line represents the rate at
which the consumer must trade one good for another at any given bundle.
Topic:

Budget Constraint

42
19)

Joe subscribes to an Internet provider that charges \$2 per hour. Draw his budget line for Internet access
on the horizontal axis and money spent on all other goods on the vertical axis assuming he has \$100 per
month to spend. Another company offers unlimited Internet access for a flat monthly fee of \$20. Draw
this budget line.

Topic:

Budget Constraint

43
20)

Lisa has an income of \$100. She spends all of her income on pizza and burritos. A pizza costs \$10 and a
burrito costs \$5. However, the store where Lisa buys her burritos has a special deal. After you've bought
six burritos, then you can buy each burrito for \$2.50. Draw Lisa's opportunity set.

Topic:

Budget Constraint

21)

Explain the difference between the marginal rate of substitution and the marginal rate of transformation.

The marginal rate of substitution is a consumer's willingness to trade one good for another based on
utility. The marginal rate of transformation is the consumer's ability to trade one good for another based
on prices.
Topic:

Budget Constraint

22)

44
An increase in a consumer's income will increase the Marginal Rate of Transformation.

False. In increase in income will result in a paralell shift of the budget constraint, leaving the slope (MRT)
unchanged.
Topic:

Budget Constraint

45
23)

Suppose Charley only purchases boardgames (B) and haircuts (H) with his income. If the price of
boardgames increases by 100% while the price of haircuts increases by 300%, how will the MRT change
(consider the budget constraint drawn on a graph with boardgames on the horizontal axis)?

Before the price change, the MRT=-pB/pH. After the price change, the MRT'= -(2)pB/(4)pH=MRT/2.
The MRT is half.
Topic:

Budget Constraint

3.4

## Constrained Consumer Choice

1)

Economists assume consumers select a bundle of goods that maximizes their well-being subject to
A)

B)

their income.
C)

relative prices.
D)

A
Topic:

## Constrained Consumer Choice

2)

46
An optimum that occurs as a corner solution
A)

## includes only one good.

B)

cannot be an equilibrium.
C)

D)

A
Topic:

3)

## The consumer is in equilibrium when

A)

MRT = MRS.
B)

Px/ Py = MUx/MUy
C)

the budget line is tangent to the indifference curve at the bundle chosen.
D)

## All of the above.

D
Topic:

47
Constrained Consumer Choice

4)

A)

B)

C)

D)

B
Topic:

48
5)

A)

## "I value my last unit of each good equally."

B)

"I am willing to trade one good for the other at the same rate that I am required to do so."
C)

D)

B
Topic:

## Constrained Consumer Choice

6)

Assume the price of beer is \$4, the price of pizza is \$10 and the consumer's income is \$250. Which
consumption bundle will NOT be the consumers choice?
A)

A (5 Beers, 5 Pizzas)
B)

B (0 Beers, 25 Pizzas)
C)

D)

49
A
Topic:

## Constrained Consumer Choice

7)

With respect to consuming food and shelter, two consumers face the same prices and both claim to be in
equilibrium. We therefore know that
A)

B)

C)

D)

C
Topic:

## Constrained Consumer Choice

50
8)

Johnny has allocated \$30 toward coffee and tea and feels that coffee and tea are perfect substitutes. Due to
differences in caffeine levels, his MRS of tea for coffee equals two. If coffee and tea sell for the same price,
Johnny will
A)

B)

C)

D)

B
Topic:

## Constrained Consumer Choice

51
9)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. Which bundle will Max choose?
A)

a
B)

b
C)

c
D)

d

B
Topic:

## Constrained Consumer Choice

52
10)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. What is the price of chicken?
A)

\$0.80/lb
B)

\$1.25/lb
C)

\$4/lb
D)

\$5/lb

D
Topic:

## Constrained Consumer Choice

11)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. If the price of burger increases,
A)

## Max will buy less burger and more chicken.

B)

Max will buy less burger and the same quantity of chicken.
C)

D)

53
D
Topic:

## Constrained Consumer Choice

12)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. What happens if Max's mother gives him 10 pounds of burger?
A)

## Max would have preferred receiving the dollar-value of the burger.

B)

Max is indifferent between this gift and the dollar-value of the burger.
C)

D)

B
Topic:

## Constrained Consumer Choice

13)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. What happens if Max's mother gives him 30 pounds of burger?
A)

## Max would have preferred receiving the dollar-value of the burger.

B)

Max is indifferent between this gift and the dollar-value of the burger.
C)

54
D)

A
Topic:

## Constrained Consumer Choice

14)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. What happens if Max receives a \$100 cash grant to buy either meat or chicken?
A)

## Max will double his consumption of both meats.

B)

Max will spend it all on burger. Because of its lower price, he can buy more of it.
C)

Max will take advantage of the gift by buying all chicken because it is the more expensive meat.
D)

A
Topic:

## Constrained Consumer Choice

15)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. Which of the following best describes Max's preferences?
A)

d>b>e

55
B)

d=b=e
C)

a=b>c
D)

a=b>e

D
Topic:

## Constrained Consumer Choice

16)

Max has allocated \$100 toward meats for his barbecue. His budget line and an indifference map are
shown in the above figure. Which of the following bundles are in Max's opportunity set?
A)

a, b, c
B)

b, d, e
C)

a, b, d
D)

B
Topic:

## Constrained Consumer Choice

17)

56
Max has allocated \$100 toward meats for his barbecue. His budget line and indifference map are shown
in the above figure. If the price of burger increases, which of the following bundles are in Max's
opportunity set?
A)

b, d, e
B)

d, e
C)

a, b, c, d, e
D)

D
Topic:

## Constrained Consumer Choice

18)

Max has allocated \$100 toward meats for his barbecue. His budget line and indifference map are shown
in the above figure. If Max is currently at point e
A)

B)

C)

D)

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D
Topic:

## Constrained Consumer Choice

19)

Max has allocated \$100 toward meats for his barbecue. His budget line and indifference map are shown
in the above figure. If Max is currently at point d
A)

B)

C)

D)

D
Topic:

## Constrained Consumer Choice

20)

If MRS > MRT, then the consumer is better off than at equilibrium.

False. MRS > MRT implies that the consumer values the next unit of "x" more than it costs to obtain it.
That is, there is a gain from trade to be made. As more "x" is purchased, MRS falls and eventually MRS =
Topic:

## Constrained Consumer Choice

58
59
21)

Joe subscribes to an Internet provider that charges \$2 per hour. He has \$100 per month to spend and is at
equilibrium by buying 10 hours of Internet access and \$80 worth of other goods. Draw the indifference
curve and budget line. If the company switches to a \$20 monthly fee for unlimited Internet access, is Joe
better off?

See the above figure. Under the new plan Joe can still purchase his original bundle and get additional
time on the Internet for free. Note that had Joe been consuming less than 10 hours at \$2 per hour, the new
pricing policy would leave him worse off.
Topic:

## Constrained Consumer Choice

22)

0.5 0.5
Suppose Joe's utility for lobster (L) and soda (S) can be represented as U = L S . Joe walks into a
restaurant with \$72. Lobsters cost \$18 each and sodas cost \$2 each. How much lobster and soda will Joe
consume if he intends to spend all his money? (There are no tax and no tips.)

60
Maximizing Joe's utility subject to his budget constraint yields:

0.5 0.5
U=L S + l(72 - 18L - 2S)
-0.5 0.5
1. dU/dL = 0.5 L S - l18 = 0
0.5 -0.5
2. dU/dL = 0.5 L S - l2 = 0
3. dU/dL = 72 - 18L - 2S = 0

From 1) and 2), S/L = 9 or S = 9L. Substituting into 3) yields 72 - 36L = 0 or L = 2. Since S = 9L, S = 18.
Thus Joe will buy two lobsters and wash it all down with 18 sodas.
Topic:

## Constrained Consumer Choice

23)

Joe's indifference map for lobster and soda is shown in the above figure along with his budget line. Will
Joe choose point a? Explain your answer in terms both of MRS and the level of utility.

Joe will not choose point a. Since the slope of his budget line tells us that he must give up only nine sodas
to get a lobster, Joe will wish to buy more lobsters and less soda than bundle a provides. From a utility
standpoint, Joe will not choose point a because another bundle that lies on a higher indifference curve is
obtainable.

61
Topic:

## Constrained Consumer Choice

62
24)

John is indifferent between canned soup and fresh soup. Canned soup sells for \$1 per serving and fresh
soup sells for \$2 per serving. Assuming that John has allocated \$4 toward soup, how will he spend it?

See the above figure. Canned and fresh soups are perfect substitutes. A corner solution exists where John
spends all \$4 on canned soup.
Topic:

## Constrained Consumer Choice

63
25)

Suppose that left shoes and right shoes must be purchased separately. Ingrid needs an equal number of
each type of shoe and has a budget of \$100 for shoes. Left shoes always cost \$1. If right shoes cost \$19
each, how many of each will Ingrid buy? If the price of right shoes increases to \$49 each, how will Ingrid
react? Explain your answer by drawing the indifference curves and budget lines.

See the above figure. Since Ingrid needs an equal number of each type of shoe, left shoes and right shoes
are perfect complements. If right shoes are \$19 each, Ingrid purchases 5 pairs of shoes. If right shoes are
\$49 each, Ingrid purchases two pairs.
Topic:

## Constrained Consumer Choice

64
26)

Johnny has \$100 to spend on books and all other goods. Books cost \$20 each and Johnny is at equilibrium
consuming 3 books and \$40 worth of other goods. Johnny's grandmom wants to give Johnny either a
book or \$20 for his birthday. Which gift does Johnny prefer? Explain using an indifference map and
budget lines.

See the above figure. Since Johnny's equilibrium book consumption exceeds the quantity of books in the
gift-in-kind, Johnny is indifferent between receiving the book or the cash. Had Johnny been consuming
less than one book, he would have preferred the cash.
Topic:

## Constrained Consumer Choice

27)

0.5 0.5
Lisa consumes only pizzas (P) and burritos (B). Her utility function is U = P B . The price of per
pizza is \$10 and the price per burrito is \$5. In equilibrium, Lisa consumes four pizzas. Using Lisa's utility
function, calculate how many burritos she consumes.

65
0.5/ 0.5 0.5 0.5
The marginal utility of pizza equals B 2P . The marginal utility of a burrito equals P /2B . In
equilibrium, the ratio of the marginal utilities will equal the ratio of prices. The ratio of marginal utilities
simplifies to B/P. The ratio of prices is 10/5. Since we know that Lisa consumes 4 pizzas, she must
consume 8 burritos.
Topic:

## Constrained Consumer Choice

66
28)

Lisa consumes only pizzas and burritos. In equilibrium, her marginal utility of pizza is 20 and her
marginal utility of a burrito is 10. The price of a pizza is \$4. What is the price of a burrito?

In equilibrium, the ratio of the marginal utility of a pizza divided by the price of a pizza must equal the
marginal utility of a burrito divided by the price of a burrito. Thus the price of a burrito must be \$2.
Topic:

## Constrained Consumer Choice

29)

Joseph has the utility function U(F,H)=10F2H, where F is the quantity of food he consumes per year and
H is the quantity of housing per week. Suppose the price of food is \$10 and the price of housing is \$5,
while Joseph has an income of \$150/week.
(a) Calculate Joseph's MRS as a function of the quantities F and H.
(b) Write out Joseph's constrained optimization problem with the information provided.
(c) Using the substitution method, solve for Joseph's optimal consumption bundle of food and housing.
(d) Show that at the optimum, Joseph consumes the bundle along the budget constraint where
MRS=MRT.

## (a) MRS = -2*10FH/10F2= -2H/F.

(b) max 10F2H subject to 10F+5H=150
(c) Solve the BC for F=15-.5H. Substitute this function of F into the utility function to get the
unconstrained maximization problem:
max 10(15-.5H)2H
The derivative is
10(15-.5H)2+10*2(15-.5H)(-.5)H=0
Solving for H=10. Plug H=10 into the BC to get F=10.
(d) The MRS = -2H/F. At the optimal bundle from (c), MRS = -2. The MRT = -10/5 = -2. Hence the
slope of the BC equals the slope of the IC at the optimal bundle.
Topic:

## Constrained Consumer Choice

30)

If a consumer views the two goods they consume as perfect substitutes, the optimal bundle will be a
corner solution. Explain.

67
Perfect substitutes are goods for which at any point you will trade one good in the same proportion for
the other. The specific utility function is U(x,y)=ax+by, and the ICs are linear throughout.
A corner solution is when the optimal bundle is all of one good and none of the other (i.e. the solution is
at the intercept of the BC and one of the axis)

True, since the MRS is constant for p.s.’s, the optimal bundle will occur at a corner
Topic:

## Constrained Consumer Choice

68
31)

Consider Jen, a consumer with preferences U(H,F)=F1/3H2/3, where H is the quantity of housing and F is
the quantity of food (per month). Suppose Jen has a stipend of \$600/month which she uses to purchase
food at a price of \$1/unit and housing at a price of \$10/unit.
a. Compute Jen's utility-maximizing bundle of goods.
b. Suppose that Jen's employer subsidizes housing by paying 50% of her total housing costs, thereby
effectively lowering the price Jen pays for housing to \$5/unit. Compute Jen's new optimal consumption
bundle.
c. How much does Jen's employer pay in total for this subsidy? How much utility does Jen enjoy with
this subsidy (compute her utility at the optimal bundle).
d. Suppose that her employer simply gave Jen the dollar cost you found in (c) as a lump sum (instead of
subsidizing housing). Will Jen gain a higher utility from the housing subsidy or the lump-sum equivalent
transfer?

## a. Jen will consume 40 units of housing and 200 units of food.

b. At a price of \$5/unit, Jen will increase housing consumption to 80 and consume 200 units of food as
before.
c. The cost to her employer is \$5 times 80 = \$400. Jen's utility is approximately 109 (utils/month).
d. Jen's optimal bundle when I=1000 is 333 units of food and 67 units of housing (approximate) and a
utility of 114 (approximately). Jen is better off from getting the lump-sum transfer.
Topic:

## Constrained Consumer Choice

32)

Suppose that the preferences a typical American has for quantities of electricity (E) and gasoline (G) is
given by
U(E,G) = a ln(E) + (1-a) ln(G)
where 0<a<1. Suppose the prices of gasoline and electricity in the units provided are both \$1/unit and
the consumer has an income of \$100. Suppose in addition, the government has chosen to ration
electricity by allowing a maximum consumption of 50 units of electricity (E≤50).
a. If a=.25, find the optimal consumption bundle of gasoline and electricity. Does the electricity
rationing constraint have an influence on consumer's choice?
b. If a=.75, find the optimal consumption bundle of gasoline and electricity. Does the electricity
rationing constraint of the government have an influence on the consumer?

For each case, the best approach is to solve while ignoring the rationing constraint. If the solution you
find violates the constraint, you know then that the optimal bundle will be where E=50.
a. The MRS = .25G/.75E = 1 = MRT or simply G=3E. Using the budget constraint:
E + 3E = 100
Solving gives E=25 and G=75. The electricity rationing does not have an effect.

69
b. The MRS=.75G/.25E = 1 = MRT or simply G=E/3. The solution from the budget constraint is E=75.
However, this violates the rationing constraint and so E=50, G=50.
Topic:

## Constrained Consumer Choice

70
33)

Howie consumes only beer (B) and donuts (D) each week with his \$100 income. Beer costs \$1, while
donuts cost only 50¢. Howie has Cobb-Douglas preferences given by:
U(B,D) = B(D-d)
where d is the quantity of donuts that his neighbor Nord consumes. Assume throughout this question
that Howie always consumes more donuts than Nord.
a. How does Nord's beer consumption influence Howie's utility function? Specifically, compute and
determine the sign of ∂U/∂d. Intuitively, what does this tell you about Howie's happiness and Nord's
consumption of donuts?
b. Holding d fixed, compute Howies's optimal consumption bundle of Beer and Donuts as functions of
Nord's consumption of donuts, d.
c. How does Nord's consumption of donuts affect Howie's optimal bundle? Specifically calculate and
determine the sign of ∂B*/∂d and ∂D*/∂d where (B*,D*) is Howie's optimal consumption bundle.

a. The derivative is -B, meaning Howie's utility decreases as Nord consumes more donuts (holding all
else fixed). Howie apparently does not like to see Nord consume donuts.
b. D*=100+.5d, B*=50-.25d.
c. ∂B*/∂d=-.25<0 and ∂D*/∂d=.5>0. As Nord consumes more donuts, Howie will consume more
donuts and less beer.
Topic:

## Constrained Consumer Choice

71
34)

Consider a consumer with the Cobb-Douglas utility function U(q1,q2) = q1 q 2 , where q1 and q2 are
the quantities of goods 1 and 2 consumed, respectively. This consumer derives a level of utility denoted
by U0. The prices of goods 1 and 2 are denoted p1 and p2.
a. Write out the Lagrangian for the consumer's expenditure minimization problem.
b. Using the Lagrangian method, derive the consumer's (expenditure-minimizing) quantity of good 1 as
functions of the variables p1, p2, and U0.
c. Derive the consumer's expenditure function, E(p1, p2, U0).

## a. The Lagrangian is:

L = p1q1 + p2q2 + λ[U0 - q1q 2 ]
where λ denotees the Lagrange multiplier.
b. The first-order conditions are:
1 q2
∂L/∂q1 = p1 – λ =0
2 q1
1 q1
∂L/∂q2 = p2 – λ =0
2 q2
∂L/∂λ = U0 - q1 q 2 = 0
Combining the first two conditions yields the familiar MRS=MRT condition:
q2 p1
=
q1 p 2
p1
or q2 = q . Substituting this into the third condition (the utility -constant constraint)
p2 1
p2
q1 = U 0 <--- expenditure-minimizing demand for good 1
p1
c. From the MRS=MRT condition, we get p1q1 = p2q2. The expenditure function is:
p2
E = p1q1 + p2q2 = 2p1q1 = 2p1U0 = 2U0 p1 p 2
p1
Topic:

## Constrained Consumer Choice

72
35)

The preferences for Californians can be represented by the following utility function:U(X,Y) = XaY1-a.
The consumer faces the budget constraint I = p.X + q.Y, where I is the agent's income, and p and q are
the prices. Suppose the government imposes a consumption restriction so that any person in the state is
allowed to consume 50 units of electricity at most.
a. If a=0.25, I=100, and both prices are equal to one, find the optimal consumption of gasoline and
electricity by the agent. Is the electricity constraint binding? (Hint: solve the problem without the 50≥X
constraint and see if the solution satisfies the constraint. If your answer then does not satisfy 50≥X, the
solution must be 50=X)
b. How does your answer in part a. change if a=0.75? Explain.
c. On a graph, illustrate the answers to parts a. and b.

## a. The consumer will choose X and Y to solve the problem

max U(X,Y) subject to 100=X+Y and X≤50
First, ignore the quantity restriction on X and solve using the lagrangian method:
L = X.25Y.75 + λ[100 - X - Y]
The derivatives are:
LX = .25X-.75Y.75 - λ
LY = .75X.25Y-.25 - λ
Lλ = 100 - X - Y
Solving the system of equations yields X = 25, Y = 75. Because X<50, the rationing constraint is satisfied.
b. Repeating the steps in a. with a=.75, the optimal bundle ignoring the constraint is X=75, Y=25. As a
result, the rationing constraint must bind, so X=Y=50.
c.

Topic:

## Constrained Consumer Choice

73
36)

Suppose Paul's utility depends on the amount of time spent playing on the Internet (x) and the amount of
time playing video games (y), and his utility function is
U(x,y) = 3x0.2 y0.8
He has 15 hours of free time to spend on these two activities each week, and his goal is to maximize his
utility.
a. Set up the Lagrangian for this constrained maximization problem.
b. What are the necessary conditions for the optimum from the Lagrangian?
c. What is the optimal amount of time spent surfing the Internet and playing video games each
week?

## a. L = 3x0.2 y0.8 + λ[15 - x - y]

b. The optimality conditions are
Lx = .6x-0.8y0.8 - = 0
Ly = 2.4x0.2y-0.2 - = 0
L = 15 – x – y = 0
c. First solve for the MRS = MRT condition using the first two conditions above:
.6x-0.8y0.8 /2.4x0.2y-0.2 = y/4x = 1
or simply y = 4x. Substitute this into the budget constraint
5x = 15
So x = 3 and y = 12. Paul will spend 3 hours on the Internet and 12 hours playing video games. What a
day!
Topic:

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