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Problem Set 3

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5 views

Problem Set 3

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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Problem Set 3

1. Ram’s preference between two commodities is represented by the following Cobb-


2 3
Douglas utility function: 𝑈 (𝑥1 , 𝑥2 ) = 𝑥1 (5) 𝑥2 (5) where 𝑥1 and 𝑥2 represent the
amount consumed of the two goods.

a) Derive the marginal utilities for both commodities as a function of 𝑥1 and 𝑥2 . Are the
marginal utilities positive? What does positive marginal utilities imply intuitively?
b) Show that the marginal utilities are diminishing i.e. marginal utility of commodity 1
declines as 𝑥1 increases and marginal utility of commodity 2 declines as 𝑥2 increases.
What does diminishing marginal utility tell you intuitively?
c) Derive MRS using the ratio of marginal utility of commodity 1 to commodity 2. Does the
absolute value of MRS diminish as 𝑥1 increases? Explain your answer.

2. Consider a utility function defined over two commodities 𝑈(𝑥1 , 𝑥2 ). Consider a positive
monotonic transformation of the above utility function of the above utility function:

𝑉 (𝑥1 , 𝑥2 ) = 𝑔[𝑈(𝑥1 , 𝑥2 )]; 𝑔 is an increasing function. Show that MRS is invariant to


positive monotonic transformation.

3. Consider the following utility function defined over two commodities:

𝑈(𝑥1 , 𝑥2 ) = −(𝑥1 − 10)2 − (𝑥2 − 10)2


(10,10) is the consumption bundle at which the consumer is satiated.

a) Draw the indifference map and derive MRS.


b) Show that the MRS can be positive or negative depending on the values of 𝑥1 and
𝑥2 .

4. Consider the following utility function for two commodities (X & Y): 𝑈(𝑥, 𝑦) = 𝑥 − 𝑦 (x
and y is the amount of two commodities consumed and you can assume that the amount
of commodity X is measured along the horizontal axis and the amount of commodity Y is
measured along the vertical axis). (We also assume that commodities are divisible i.e.
fractional amounts are perfectly allowed)

a) What can be said regarding the two commodities? Draw the indifference map for this
utility function i.e. indifference curves corresponding to various utility levels (like
U=-2, U=-1, U=0, U=1, U=2 and so on)
b) Suppose we change the utility function and write it in the following way: 𝑈 (𝑥, 𝑦) =
𝑦 − 𝑥. Do you think that the nature of two commodities become different under this
new utility function? Draw the indifference map for this new utility function i.e.
indifference curves corresponding to various utility levels (like U=-2, U=-1, U=0,
U=1, U=2 and so on) (Don’t change the axis i.e. X is still measured along the
horizontal axis and Y is still measured along the vertical axis)

c) Now, assume the following utility function:

𝑈 (𝑥, 𝑦) = 𝑥 − 𝑦; 𝑥 ≤ 10
𝑈(𝑥, 𝑦) = 𝑦 − 𝑥; 𝑥 > 10
Draw the indifference map for this utility function i.e. indifference curves corresponding to
various utility levels. (Hint: Answer question (a) and question (b) and then think about (c) as a
third step). What can you say about the indifference map in this case? (from mathematical point
of view). Can you indicate the weakly preferred set in the diagram.

5. Suppose a consumer’s preference is defined over two commodities. One of the


commodities is a discrete good (i.e. only measured in integer units). The other
commodity is perfectly divisible (i.e. measured in both fractional and integer amounts).
Draw a proper diagram and show that it is not possible to draw a continuous indifference
curve in this case i.e. an indifference set is a set of consumption bundles which can’t be
connected by a smooth curve.

6. Consider the following utility function:


𝑈 (𝑥1 , 𝑥2 ) = 𝑥1 𝑥2 2
(i) Derive the MRS at any point on an indifference curve generated from the above
utility function. Is the MRS diminishing?
(ii) Show that an appropriate positive monotonic transformation of the above utility
function can make the sum of exponent equals 1.
(iii) What type of preference relation the above utility function represents? Are the
indifference curves generated from the above utility function convex to origin?
Explain

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