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EC202: Intermediate Microeconomics

Semester 1, 2023
Tutorial 2 SOLUTIONS (Week 3)
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Question 1

What does the assumption that preferences are complete mean about the consumer’s ability to
rank any two baskets?

By requiring preferences to be complete, economists are ensuring that consumers

will not respond indecisively when asked to compare two baskets. A consumer will
always be able to state that either A is preferred B, B is preferred to A, or that she is
indifferent between A and B.

Question 2

How will a change in income affect the location of the budget line?

An increase in income will shift the budget line away from the origin in a parallel
fashion expanding the set of possible baskets from which a consumer may choose. A
decrease in income will shift the budget line in towards the origin in a parallel
fashion, reducing the set of possible baskets from which a consumer may choose.

Question 3

How will an increase in the price of one of the goods purchased by a consumer affect the
location of the budget line?

If the price of one of the goods increases, the budget line will rotate inward on the
axis for the good with the price increase. The budget line will continue to have the
same intercept on the other axis. For example, suppose someone buys two goods,
cups of coffee and doughnuts, and suppose the price of a cup of coffee increases.
Then the budget line will rotate as in the following diagram:
Doughnuts

BL2 BL1
Coffee
Question 4

Why can’t you plot the total utility and marginal utility curves on the same graph?

The two cannot be plotted on the same graph because utility and marginal utility are not
measured in the same dimensions. Total utility has the dimension U , while marginal
utility has the dimension of utility per unit, or U / y where y is the number of units
purchased.

Question 5

If the consumer has a positive marginal utility for each of two goods, why will the consumer
always choose a basket on the budget line?

Relative to any point on the budget line, when the consumer has a positive marginal utility
for all goods she could increase her utility by consuming some basket outside the budget
line. However, baskets outside the budget line are unaffordable to her, so she is constrained
(as in “constrained optimization”) to choosing the most preferred basket that lies along the
budget line.

Question 6

At an optimal interior basket, why must the marginal utility per dollar spent on all goods be
the same?

At an interior optimum, the slope of the budget line must equal the slope of the
indifference curve. This implies
MU x = Px
MRS x, y =
MU y Py
 This can be rewritten as

MU x MU y
=
P P
x y

which is known as the “bang for the buck” condition. If this condition does not hold
at the chosen interior basket, then the consumer can increase total utility by
reallocating his spending to purchase more of the good with the higher “bang for the
buck” and less of the other good.

Question 7

Adam consumes two goods: housing and food.

a) Suppose we are given Adam’s marginal utility of housing and his marginal utility of food
at the basket he currently consumes. Can we determine his marginal rate of substitution
of housing for food at that basket?

Yes, we can determine the MRS as

MUh
MRSh, f =
MU f
b) Suppose we are given Adam’s marginal rate of substitution of housing for food at the
basket he currently consumes. Can we determine his marginal utility of housing and his
marginal utility of food at that basket?

No, when we know the MRS, all we know is the ratio of the marginal utilities. We
cannot “undo” that ratio to determine the individual marginal utilities. For example, if
we know that MRSh,f = 5, it could be the case that MUh = 5 and MUf = 1, but it could
equivalently be the case that MUh = 10 and MUf = 2. Clearly, there are countless
combinations of MUh and MUf that could lead to some particular value of MRSh,f, and
we have no way of inferring which is the right one.

Question 8

Suppose a consumer has preferences over two goods that can be represented by the quasi-linear
utility function U(x, y) = 2√x + y. The marginal utilities are MUx = 1/√x and MUy = 1.

a) Is the assumption that more is better satisfied for both goods?

Yes, the “more is better” assumption is satisfied for both goods since both marginal
utilities are always positive.

b) Does the marginal utility of x diminish, remain constant, or increase as the consumer
buys more x? Explain.
 The marginal utility of x increases as the consumer buys more x .

c) What is the expression for MRSx,y?

1
MRS x , y = x= 1
1 x

d) Is the MRSx,y diminishing, constant, or increasing as the consumer substitutes more x for y
along an indifference curve?

As the consumer substitutes x for y , the MRS x, y will diminish.

***The End***