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Practice Problems Icutility

1. Two indifference curves representing different levels of utility cannot intersect, as this would violate the axiom of monotonicity. 2. If both goods are "bad" for the individual, indifference curves will be negatively sloped, as the individual prefers less of both goods. The marginal rate of substitution will increase as the quantity of one bad increases, as the individual requires more of the other bad to maintain utility. 3. If one good is neutral, the marginal rate of substitution of that good for the other good is 0, as the quantity of the neutral good does not impact utility.

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45 views4 pages

Practice Problems Icutility

1. Two indifference curves representing different levels of utility cannot intersect, as this would violate the axiom of monotonicity. 2. If both goods are "bad" for the individual, indifference curves will be negatively sloped, as the individual prefers less of both goods. The marginal rate of substitution will increase as the quantity of one bad increases, as the individual requires more of the other bad to maintain utility. 3. If one good is neutral, the marginal rate of substitution of that good for the other good is 0, as the quantity of the neutral good does not impact utility.

Uploaded by

Siva Kumar
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Practice Problems Indifference Curves, Utility Functions

1. Assume preferences are well-behaved (that is, monotonic and convex). Can two indifference curves (representing two different levels of utility) intersect? (That is, can they cross each other?) (Hint: Try using the Axiom of monotonicity to prove that they cannot intersect) 2. If both pepperoni and sausages are bad for me, will my indifference curves be positively or negatively sloped? How can you interpret the change in MRS in this case? (assume that the Axiom of Convexity holds) 3. If good 1 is a neutral good, what is the MRS of good 1 for good 2? 4. Which of the following are monotonic transformations of a utility function u? (a) 2 u-10 (b) ln u (c) u 2 , u > 0 (d) u 3 (e) u 2 , u < 0 5. What kind of preferences are represented by a utility function of the form (I) u ( x, y ) = x + y (II) u ( x, y ) = x + y (III) u ( x, y ) =12 x +12 y (IV) u ( x, y ) = xy (V) u ( x, y ) = x 2 y 2

Answer Key 1.

Refer to the above figure. Suppose, by way of arriving at a contradiction, indifference curves 1 and 2 represent the same level of utility but cross each other at the point B. Take any other bundle on indifference curve 1, say C. Now choose a bundle on the other indifference curve that has more of both the goods (and hence lies to the north-east of C), say A. Then by the axiom of monotonicity we get A

C.

Again, since B and C are on the same IC (gives the same utility), B ~ C, and since B and A are on the same IC, A ~ B. Therefore, by axiom of transitivity, A ~ C, a contradiction to A C. Hence two indifference curves representing same utility levels cannot intersect.

2.

If both pepperoni and sausage are bad for me, my indifference curves look like in the above figure- at any given point, more of one bad has to be compensated by less of the

other to keep my utility unchanged and hence my indifference curves are negatively sloped. I like less of both the bads and hence my preference direction is to the southwest. Assuming that I can only have non-negative amounts of both the bads, my most preferred point is the origin- 0 units of both the bads. By the axiom of convexity, my better set is convex. The (absolute) slope of the ICs get steeper and steeper which means the MRS increases as I increase the quantity of pepperoni. We know MRS at any point gives us the amount of good 2 (its a bad here!) that I am willing to give up to increase good 1 by 1 additional unit. Increasing MRS means that as I increase the amount of one bad (pepperoni) by equal amounts, I want to give up the other bad (sausage) by more and more amount to keep my utility unchanged.

3.

Here I dont care about the quantity of good 1. So the amount of good 2 that I am willing to give up to get one more unit of good 1 (which is what MRS is, by definition) is 0. Mathematically, the (absolute) slope of the IC = MRS = 0.

4. (a), (b), (c), (d) are (increasing) monotonic transformations; (e) is not (in fact it is a decreasing monotonic transformation ends up ordering bundles in the reverse order)

5.

(I), (II), (III) represent an indifference map like above (they are monotonic transformations of each other and just re-labels the utility levels under different functions). Hence the goods are perfect substitutes of each other. It will be a good exercise to see the different levels of utility that a given curve represents under different monotonic transformations.

(IV), (V) represent an indifference map like above. Note that both the goods are goods (in the sense that more is better), since utility increases as I increase one or both of them (mathematically, marginal utilities are positive); hence my preference direction is to the northeast (more of both).

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