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A5 Solution

The document discusses various concepts in consumer theory, including utility maximization, marginal utility, and the effects of income and substitution on demand. It provides examples of utility functions, budget constraints, and the implications of changes in prices and income on consumer choices. Additionally, it covers the characteristics of Giffen goods and the impact of technological improvements on supply.

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Muskan Jindal
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31 views3 pages

A5 Solution

The document discusses various concepts in consumer theory, including utility maximization, marginal utility, and the effects of income and substitution on demand. It provides examples of utility functions, budget constraints, and the implications of changes in prices and income on consumer choices. Additionally, it covers the characteristics of Giffen goods and the impact of technological improvements on supply.

Uploaded by

Muskan Jindal
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1.

Consider a differentiable and strictly convex utility function U(x1,x2) and budget line of the
consumer P1x1+P2x2 = I. Condition for utility maximization is
a. MU1/P1=MU2/P2
b. MRS=slope of budget line
c. Ratio of the marginal utilities of x1 and x2=P1/P2
d. All the above

All three options are equivalent.

2. Consider the utility function U(x1,x2)=log x1+log x2 and budget line of the consumer as
3x1+4x2=120. Optimal bundle of goods x1 and x2 consists
1/𝑥1 1/𝑥2
= solve this with budget constraint to get
3 4

x1*= 20, x2*= 15


3. Choose the correct statement for marginal utility and marginal rate of substitution
a. Marginal utility is not ordinal and changes for a monotonic transformation of the utility
function
b. MRS is ordinal and does not change for a monotonic transformation of utility function
c. Both
d. None
4. Choose the correct statement
a. Quasi linear preferences are linear in one good and non linear in other good
b. U = min{ax, by} represents perfect substitutes
c. U = ax+by represents perfect complements
d. All of the above

Only a. is correct others are wrong. U=min{ax, by} represents complements and U=ax+by represents
substitutes.

5. Suppose that at current consumption levels an individual’s marginal utility of consuming an


extra pizza is 20 whereas the marginal utility of consuming an extra cold drink is 4. Then the
MRS (of cold drinks for pizzas) - that is, the number of pizzas the individual is willing to give
up to get one more cold drink is (MU(cold drink)/MU(Pizza)=MRS=∆Pizza/∆Cold Drink;
4/20=MRS)
a. 5
b. 2
c. 1/2
d. 1/5
6. Rohan likes both tea and coffee and his preference for these is represented by a utility
function U = T + C where T represents the no. of cups of tea and C no. of cups of coffee he
consumes. Total money he has allocated for having tea or coffee is 200 and price for a cup of
tea and coffee in market always fluctuate. Choose the correct alternative regarding his
optimal bundle of tea and coffee
a. He will consume only tea if PT<PC
b. He will consume only coffee if PC<PT
c. He is indifferent between tea (T) and coffee when PC=PT
d. All of these are true (as the optimal bundle will depend on slope of budget line or we
may say that as only the sum matters, Rohan will consume cheaper one and when both
prices are same, he is indifferent)
7. A consumer faces following maximizing problem if he wants to consume bread and butter in
breakfast U = min{S/2, B} given his budget constraint for breakfast as S + 2B = 20. Here S is
the no. of bread slices and B is the no. of butter cubes he consumes. Optimal no. of slices of
bread and butter cubes he will consume is
By the intersection of S/2=B and budget line we get S*=10 and B*=5. One may draw
appropriate graph showing the optimal point. Tangency condition will not hold as function is
not differentiable at kink.
S*=………………… (10)
B*= ………………… (5)
8. If the income effect is in the same direction as the substitution effect then the good is
a. Normal
b. inferior but not Giffen
c. Giffen
d. There is not enough information to answer
9. If the income effect is in the opposite direction as the substitution effect but the substitution
effect dominates then the good is
a. Normal
b. inferior but not Giffen
c. Giffen
d. There is not enough information to answer
10. A good is called giffen good when
a. It must be an inferior good
b. It must account for a large fraction of consumer’s budget
c. Both are true
d. None is true
11. An improvement in technology
a. Changes the quantity supplied
b. Shifts supply curve outward
c. Shifts supply curve inward
d. No change

The market demand curve for blankets is P=300-Q and the market supply curve is P=60+2Q. Answer
the following questions. The equilibrium quantity and price are

Solving for QD=QS gives (point E in graph)

13. P*= ……………….. (220)


14. Q*= ………………. (80)
15. Consumer surplus is (2 points)

a. 4500

b. 2700

c. 3200

d. 4200

Area DEP*=1/2 * 80 * 80=3200

16. Producer surplus is (2 points)


a. 6400

b. 4600

c. 3700

d. 2700

Area SEP*= ½ * 80 * (220-60)= 6400

17. Which of the following is a correct statement about the price of butter and the quantity of
butter bought and sold at equilibrium point
a. An increase in price of milk, which is a raw material to produce butter, gives rise to lower
equilibrium price and higher quantity of butter bought and sold
b. A decrease in average income levels gives rise to lower equilibrium price and lower
quantity of butter bought and sold
c. Both
d. None

Change in income is an exogenous change so entire demand curve will shift leftward and the new
equilibrium with unchanged supply will give rise to lower equilibrium price, P1* and lower quantity of
butter sold, Q1*.

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