Assignment-3

1. Please write your name, and your section/recitation time (e.g. MWF 10am,
or F 1 pm) on top of your solutions.

2. Problem sets are due IN SECTION/RECITATION. Late Problem

sets will not be accepted under any circumstances.
Questions:

1. Are the following statements true, false? Please give an explanation.

(a) (8 points) If pork chops and mashed potatoes are the only
goods consumed and they are perfect complements, then
neither can be an inferior good.
(b) (8 points) Ursula and Jessica are dining at Stanley’s Surf and
Turf, which sells only lobsters and steaks. An economics student
working part-time in the restaurant asks the two customers about
their marginal rates of substitution (MRS) and discovers that Ur
sula’s MRS of lobster for steak is –2. Ursula and Jessica face the
same prices for the two foods.Therefore, we know Jessica’s MRS
of lobster for steak must also equal –2.

2. (8 points) In the first week of July, Bob’s favorite store charges $2.50 for
an ice cream and $1.50 for a soda. Bob spends all his income on ice-
cream and soda and chooses to consume 6 ice-creams and 10 sodas. By
the first week of August, prices have risen to $3 per ice-cream and $2 per
soda. Bob’s income has also changed. He still only consumes ice-cream
and soda, but he now buys 4 ice-creams and 20 sodas. Is Bob’s behavior
in the two weeks consistent with valid indifference curves? Can you
determine in which week Bob is better off? Explain.
3. Anna spends all of her income on shirts (S) and jeans (J ). Anna’s
√

preferences can be represented by the utility function U (S, J ) = 3 SJ .

(a) (10 points) Derive the demand functions for shirts and jeans in
terms of the price of shirts (P S ), the price of jeans (P J ), and
income (I ).

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and
Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare
(http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].
 (b) (4 points) Draw the Engel curve for shirts.
(c) (3 points) Suppose the price of a shirt is $4, the price of a pair
of jeans is $16, and Anna has $128 income. What bundle of
shirts and jeans (S, J ) maximizes Anna’s utility?

(d) (2 points) Suppose the price of a shirt increases to $16. What

bundle of shirts and jeans will Anna demand now?

(e) (8 points) Devastated by the sudden price increase, Anna

decides to ask her brother for money to help finance her
clothing pur chases. How much total income does Anna need
to remain as happy as she was before the price change?

(f) (3 points) If Anna has exactly enough income to keep her as

happy as she was before the price change, what bundle of
shirts and jeans will Anna demand?

(g) (10 points) Unfortunately, Anna’s brother refuses to give Anna

any money. She is now back to the situation in part c: the price
of shirts has increased from $4 to $16, and her income
remains un changed at $128. Decompose the total change in
consumption of shirts and jeans purchased into a substitution
effect and an income effect. In a clearly-labeled diagram with
shirts on the horizontal axis, draw the income and substitution
effects of the increase in the price of a shirt.

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) (4 points) At the market-clearing price, how many oranges

does each member of tribe A buy? What is the price elasticity
of de mand by a member of tribe A at this point?

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and
Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare
(http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].
 (b) (4 points) At the market-clearing price, how many oranges
does each member of tribe B buy? What is the price elasticity
of de mand by a member of tribe B at this point?

(c) (12 points) What is the market demand for oranges in this
econ omy? Is the market demand function linear? If not, where
is the kink?

(d) (6 points) 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) (10 points) 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.

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and
Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare
(http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].