Problem Set 1 where bs is the number of burgers she consumes each

Microeconomic Theory: A Mathematical Approach (Con- month, and ms is her phone usage measured in units of
sumer’s Problem1 ) hundred minutes.
With similar notation, Abhishek’s utility function is
1. You have just emerged from medical school with a debt ua (ba , ma ) = ba ma .
service burden of $25,000 per year, and have set up prac- Find the optimal choice — the choice of phone plan, the
tice. You have to decide how hard to work. For each hour number of minutes spent on the phone, and the number
of work, you expect to earn $50 (after subtracting expenses of burgers eaten — for each.
of maintaining your office, taxes, etc.). Your utility func-
tion for a full year is U (I, H) = ln(I) + 2 ln(5000 − H), 5. Consider the utility function u(x, y) = min{2x + y, x + 2y}
where H is the number of hours you work during the year,
and I is what is left of your annual income after expenses, (a) Draw the indifference curve for u(x, y) = 20. Shade
taxes, and debt service. the area where u(x, y) ≥ 20.
px
(b) For what values of will the unique optimum be
(a) What is your budget constraint linking I and H? py
x = 0.
(b) Find your optimal number of hours of work. px
(c) For what values of will the unique optimum be
(c) If taxes go up so you are left with only $40 per hour py

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of work, will you work more or fewer hours? Explain y = 0.
the economic intuition for the result. (d) If neither x and y is equal to zero, and the optimum

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x
2. There are two goods, whose quantities are denoted by X is unique, what must be the value of in optimum?
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and Y , each being a real number. An individual’s con-
sumption set consists of all (X, Y ) such that X ≥ 0 and 6. Consider an individual who consumes three goods. His

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Y > 1. His utility function is: U (X, Y ) = 4 ln(X + 2) +
ln(Y − 1). The price of X is p and that of Y is q; total
income is I. Assume q < I. Solve the consumer’s problem.
utility function is given by: u(x, y, z) = min{x + y, x + z}.
Solve the consumer’s problem.

7. A mathematician named Donic consumes either gin or

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3. Denote a consumer’s daily hours of work by h, and hours tonic. His preferences are rare because he thinks in the
of non-work by n = 24 − h. Consider a consumer who has square in a way that is almost sardonic. Specifically, Donic
on

no other source of income than wages for hours worked, prefers larger drinks to smaller drinks but requires that the
and no debt or other obligations. He consumes what square of the amount of lime in a drink equal the sum of
he earns each day. Writing c for the rupees amount of the squares of the amounts of gin and tonic. Find a utility
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his consumption, suppose his utility function is u (c, n) = function that represents Donic’s preferences. Find Donic’s
ln (c) + 3 ln (n). All these quantities are to be treated as demand functions for lime, gin and tonic.
continuous variables.
8. Give a utility function to represent Tommy’s preferences.
(a) Suppose the wage rate is Rs. 10 per hour. Write (Ref. 3.12(a), pg. 29 Workouts in Intermediate Mi-
down the consumer’s utility function and budget con- cro Economics by Hal Varian.) Also plot an indiffer-
straint with c and h as the choice variables. How ence curve representing Tommy’s mother’s preferences,
many hours will he choose to work, and what will be Utility= −(D) = −(|7 − M | + |2 − C|). (Ref. 3.12(b),
the resulting utility? pg. 30 Workouts in Intermediate Micro Economics by Hal
Varian.)
(b) Suppose the wage rate is Rs. 10 per hour for the
first 8 hours of work each day, and Rs. 30 per hour 9. Consider a consumer with utility function u(x1 , x2 ) =
for each daily hour of work beyond the first 8. Write 1/2 1/2
x1 x2 and income of Rs. 15,000 per month. Suppose
down the consumer’s utility function and budget con- that prices are p1 = 1 and p2 = 1 and that the consumer
straint with c and h as the choice variables. How spends his entire paycheck each month. The consumer’s
many hours will he choose to work, and what will be boss asks him to move to a new city that is identical to
the resulting utility? his current city except that p1 = 1 and p2 = 2. The boss
4. Consider two graduate students, Sonali and Abhishek. offers no raise in pay. The consumer tells his boss: “Ask-
Each has a monthly allowance of Rs. 100, which can be ing me to move is just like if I stayed here and you cut my
spent on two things: burger, and talking to friends back pay by Rs. A. I would be willing to move to the new city,
home on the phone. Each burger costs Rs. 10. The phone but you would have to pay me Rs. B more for me to be
company offers two plans. The first has no fixed fee, and willing to do it.” Find values for A and B.
charges 10 paise per minute of use. The second has a fixed 10. Sam enjoys both tea and coffee equally. However, he
fee of Rs. 40 per month, plus 3 13 paise per minute of use. prefers to have only one at a time (i.e. he likes to have
4
Sonali has the utility function us (bs , ms ) = (bs ) ms , either tea or coffee and not both at a time). He likes to
1 Also solve the past year exam problems from this topic. Re-
have a cup of tea with exactly two spoonful of sugar and
fer: http://economicsentrance.weebly.com/lessons.html. Contact: econ- a cup of coffee with exactly one spoonful of sugar. One
[email protected] evening, he goes to a coffee shop with Rs. M in his pocket

1
 and makes his order. The coffee shop is owned by a stingy 16. Tiger consumes two goods, x and y and his utility function
√
business man, who charges price ps for each teaspoonful is u(x, y) = min{ xy, x}. Draw a graph, showing a few of
of sugar bought, and pt and pc per cup for tea and coffee, Tiger’s indifference curves. What is Tiger’s Marshallian
respectively. Give a utility function that represents Sam’s demand function for each of the two goods?
preferences and also the demand function for sugar, tea
and coffee in each of the following cases: 17. Consider the following functions f1 (x) = max{x, 1} and
f2 (x) = min{x2 , 4}. Show the following sets on a plane:
(a) If Sam prefers more cups of tea/coffee to less.
(a) {(x, y)|y ≥ f1 (x)}
(b) If Sam only enjoys upto one cup at a time, any addi-
(b) {(x, y)|y ≥ f2 (x)}
tional consumption does not add to his satisfaction.
(c) {(x, y)|y = max{f1 (x), f2 (x)}}
11. Suppose u(x, y, z, w) = xy + wz. Find the demand func-
tion for x.

12. A consumer of three goods has utility function u(x, y, z) =

(min{x, y})a z a , with 0 < a < 1. Derive the demand func-
tions for x, y and z.

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13. Solve the consumer’s problem and find the demand func-
tion for x for each of the following utility functions. Also

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consider a price change from p = (2, 1) to p0 = (1, 1) and
let income be 100, decompose the total price effect into in-

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come effect and substitution effect using Hicksian Method
and Slutsky Method for all the cases below.

(a) u(x, y) = y 2 + x
(b) u(x, y) = max{min{3x, 3y}, x + y}
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(c) u(x, y) = x2 + 4y 2 + 4xy
(d) u(x, y) = [x+y], where [.] denotes the greatest integer
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function.
(e) u(x, y) = max{x, 2y}
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14. Consumer has a utility function U (x, y, z) =

median{x, y, z}. Find the demand function for x.

15. Consider a consumer’s problem:

maxx u(x1 , x2 )
p1 x1 + p2 x2 ≤ M
x = (x1 , x2 ) ≥ 0.

One way to rule out the potential that the non negativity
constraints aren’t binding is to look at the marginal rate
of substitution (MRS) when one of the factors gets arbi-
trarily close to zero. For the utility function u(x1 , x2 ), the
MRS12 (x1 , x2 ) is the change in the amount of x2 required
to keep the function u the same when x1 changes by a
small amount. MRS12 (x1 , x2 ) is read “the marginal rate
of substitution of good 1 for good 2 at (x1 , x2 )”

(a) Consider the function u(x1 , x2 ) = x1 x2 . Start-

ing from a point where x1 , x2 > 0, what happens
to the MRS12 as x1 grows smaller and approaches
zero i.e., limx1 →0 MRS12 (x1 , x2 )? What happens to
limx2 →0 MRS21 (x1 , x2 )?
(b) Consider the function u(x1 , x2 ) = x1 + x2 . What is
limx1 →0 MRS12 (x1 , x2 )?
(c) Consider u(x1 , x2 ) = ln(x1 ) + x2 . What is
limx1 →0 MRS12 (x1 , x2 ) and limx2 →0 MRS21 (x1 , x2 )?