---------------------------------------------------------------------------------------------------------------------

EC202: Intermediate Microeconomics

Semester 2, 2024
Tutorial 2 SOLUTION (Week 3)
---------------------------------------------------------------------------------------------------------------------
Question 1

a) 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 to B, B is preferred to A, or that she is
indifferent between A and B.

b) 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.

c) 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 2

a) Discuss the significance of composite goods in the study of consumer choice.

First, consumers typically allocate income to more than two goods. Second,
economists often want to focus on the consumer’s response to purchases of a single
good or service. In this case, it is useful to present the consumer choice problem
using a two-dimensional graph. Since there are more than two goods the consumer
is purchasing, however, an economist would need more than two dimensions to
show the problem graphically. To reduce the problem to two dimensions,
economists often group the expenditures on all other goods besides the one in
question into a single good termed a “composite good.” When the problem is shown
graphically, one axis represents the composite good while the other axis represents
the single good in question. By creating this composite good, the problem can be
illustrated using a two-dimensional graph.

b) Discuss the difference between an interior optimum and a corner point optimum in the
theory of consumer choice

With an interior optimum the consumer is choosing a basket that contains positive
quantities of all goods, while with a corner point optimum the consumer is choosing
a basket with a zero quantity for one of the goods. The tangency condition usually
does not apply at corner optima.

c) 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.

d) If the consumer has a positive marginal utility for each of the 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.

e) What does the assumption that more is better imply about the marginal utility of a good?

If more is better, then the marginal utility of a good must be positive. That is, the
total utility must increase if the consumer consumes more of the good.

f) Discuss the difference between an ordinal ranking and a cardinal ranking

 An ordinal ranking simply orders the baskets, but does not give any indication as to
how much better one basket is when compared with another; only that one is better.
A cardinal ranking not only orders the baskets, but also provides information
regarding the intensity of the preferences. For example, a cardinal ranking might
indicate that one basket is twice as good as another basket.

Question 3

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 4

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 decreases as the consumer buys more x . You can insert
different positive values of x (for example, 1, 2, 3, 4, etc.) and verify.
 c) What is the expression for MRSx,y?

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.

Question 5

Consider the utility function U(x, y) = 3x + y, with MUx = 3 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 remains constant at 3 for all values of x.

c) What is MRSx, y?

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

indifference curve?

The remains constant moving along the indifference curve.

***The End***