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Problem Set 4A

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17 views

Problem Set 4A

Uploaded by

parthkelkarsewa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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1.

Find the optimal consumption bundle for a consumer with the utility function

3
( )
𝑢(𝑥1 , 𝑥2 ) = 𝑥12 𝑥2

and the budget constraint is 3𝑥1 + 4𝑥2 = 100

2. Consider the following utility function:

𝑢(𝑥1 , 𝑥2 ) = 𝑙𝑛𝑥1 + 𝑙𝑛𝑥2

𝑥1 and 𝑥2 are the amount consumed of the two commodities. 𝑃1 and 𝑃2 are the prices of these
two commodities.
(i) Derive the Hicksian demand function for the two commodities from the
consumer’s expenditure minimization exercise (you need to assume that a
consumer minimizes expenditure in order to achieve at least a utility level 𝑢− ).
Show all the steps appropriately.

(ii) Derive the expenditure function.

(iii) Is expenditure function an increasing function in prices? Explain from the


expression derived in part (ii).

(iv) Show that the expenditure function is a linearly homogeneous function in prices
(i.e. if you multiply all the prices by some constant t, total expenditure will
increase by the constant t; t>0).

(v) What happens to the Hicksian demand function for the commodities when all the
prices increase by some constant t (i.e. you multiply all the prices by t)? Explain
using the expression derived in part (i).

3. A consumer’s preference is represented by the following utility function:

𝑢(𝑥1 , 𝑥2 ) = 𝑥12 𝑥23

The quantity consumed of the two goods are 𝑥1 and 𝑥2 respectively. Prices of the two
goods are 𝑃1 and 𝑃2 respectively.

(i) Derive the marginal utilities of both the commodities and MRS at any point
along the indifference curve.
(ii) When the consumer is consuming the best bundle he can afford, what fraction
of his income, he is spending on commodity 1.

.4. Think of a consumer with the following utility function: 𝑢 (𝑥1 , 𝑥2 ) = ( 𝑥1 − 𝑥2 )5


where 𝑥1 and 𝑥2 denote the amount of commodity 1 and commodity 2 respectively.

(i)Suppose Y = (𝑦1 , 𝑦2 ) & 𝑍 = (𝑧1 , 𝑧2 ) are consumptions bundles which are indifferent to each other
and follow the preference relation represented by the above utility function. Write down the exact
mathematical relationship between bundle Y & bundle Z.

(𝑦1 and 𝑦2 are the amount of commodity 1 and commodity 2 respectively in bundle Y;
𝑧1 and 𝑧2 are the amount of commodity 1 and commodity 2 respectively in bundle Z)

(ii) Derive the marginal utilities (i.e. algebraic expression of the marginal utilities) for both
the commodities (i.e. commodity 1 and commodity 2) for the above utility function? What
can you say about the sign of the marginal utilities?

(iii) Derive the Marginal Rate of Substitution (MRS) for any point along an indifference
curve corresponding to the above utility function using the relation between MRS and
marginal utilities you know.

(iv) What happens to the absolute value of MRS for the above utility function when 𝑥1 i.e.
amount of commodity 1 increases (Assume that commodity 1 is measured along the horizontal axis
and commodity 2 is measured along the vertical axis)?

(v) Is the preference relation (corresponding to the utility function in this question) monotonic?
Answer this with an appropriate example.

(vi) Think of another utility function of the following form:

𝑣 (𝑥1 , 𝑥2 ) = ( 𝑥1 − 𝑥2 )10
Are utility functions 𝑢 (𝑥1 , 𝑥2 ) and 𝑣 (𝑥1 , 𝑥2 ) representing the same preference relation?
(vi) What can you say about the optimal choices for utility function 𝑢(𝑥1 , 𝑥2 ) for any given
prices and income.

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