PS6 2

Download as pdf or txt
Download as pdf or txt
You are on page 1of 3

Problem Set VI

Slutsky Equations

1. Gentle Charlie, vegetarian that he is, continues to consume apples and bananas. His utility
function is 𝑈(𝑥𝐴 , 𝑥𝐵 ) = 𝑥𝐴 𝑥𝐵 . The price of apples is $1, the price of bananas is $2, and
Charlie's income is $40 a day. The price of bananas suddenly falls to $1. Find the
substitution and income effect of the price change for apples and bananas.

2. Neville's passion is fine wine. When the prices of all other goods are fixed at current levels,
Neville's demand function for high quality claret is q = 0,02m − 2p, where m is his income,
p is the price of claret (in British pounds), and q is the number of bottles of claret that he
demands. Neville's income is 7,500 pounds, and the price of a bottle of suitable claret is 30
pounds. The price of wine rises to 40 pounds, find the substitution and income effect.

1
3. A consumer has the utility function 𝑈(𝑥, 𝑦) = 𝑥 + 2𝑦 2 . The price of good x is 2 and the
price of good y is 1. The consumer’s income is 20.
a) If the price of good y rises to 2, then entire change in demand for y is due to the
substitution effect.
b) Find the substitution and income effect of the price change for x

4. Mario has a small garden where he raises eggplant and tomatoes. He consumes some of
these vegetables, and he sells some in the market. Eggplants and tomatoes are perfect
complements for Mario, since the only recipes he knows use them together in a 1:1 ratio.
One week his garden yielded 30 pounds of eggplant and 10 pounds of tomatoes. At that
time the price of each vegetable was $5 per pound.
a) What is his optimal consumption level?
b) Suppose that before Mario makes any trades, the price of tomatoes rises to $15 a pound,
while the price of eggplant stays at $5 a pound. What is now his optimal consumption
level?
c) Find substitution effect, ordinary income effect and endowment income effect.
5. Suppose a dairy farmer produces 40 quarts of milk a week. The price of milk is $3/quart.
𝑚
His demand function for milk is: 𝑥 = 10 + 10𝑝

a) What is his optimal consumption level?


b) Suppose the price of milk changes to $2/quarts, by how much does his demand
change?
c) Find substitution effect, ordinary income effect and endowment income effect.

Index Numbers

6. In 1991, good x cost $2 and good y cost $1. The current price of good x is $6 and the
current price of good y is $2. In 1971 the consumption bundle was (x, y) = (3, 6). The
current consumption bundle is (x, y) = (6, 4). The Laspeyres index of current prices relative
to 1991 prices is closest to which of the following numbers? (Hint: The Laspeyres price
index uses the old quantities for the weights)
a) 2.50
b) 3.67
c) 2.75
d) 0.27
e) 1.27

Revealed preferences

7. The strong axiom of revealed preference requires that if a consumer chooses x when he can afford
y and chooses y when he can afford z, then he will not choose z when he can afford x. True/False?

8. Rudolf obeys the weak axiom of revealed preferences. His preferences don’t change over time.
One year he could afford bundle x but bought bundle y. If another year he buys bundle x, then he
can’t afford bundle y. True/False?
9. When prices are ($6, $3), Holly chooses the bundle (9, 18), and when prices are ($1, $2)
she chooses the bundle (8, 14).
a) The bundle (9, 18) is revealed preferred to the bundle (8, 14) and she does not
violate WARP.
b) She violates SARP but not WARP.
c) The bundle (8, 14) is revealed preferred to the bundle (9, 18) and she does not
violate WARP.
d) She violates WARP.
e) None of the above.

You might also like