Chapter 1

Question 1

Suppose we have 8 people who are willing to rent a shop for their business. Their reservation prices
are given below:

Person : = A B C D E F G H

Prices : = 40 25 30 35 10 18 15 5

(a) Plot the market demand for the given case. (Hint: When the market price is equal to some
consumer i’s reservation price, there will be two different quantities of shops demanded, since
consumer I will be indifferent between having or not having the shop)
(b) Suppose the supply of shops is fixed at 5 units. In this case, there shall be a whole range of
prices that will be equilibrium prices. What is the highest price that will make the demand for
shops to be equal to 5 units?
(c) What is the lowest price that would make the market demand equal to 5 units?
(d) With a supply of 4 units, which of the 8 people end up getting the shops?

Chapter 2
Question 1

On the planet Alienstan, there are two kinds of money, blue money and red money. Every commodity
has two prices – a red-money price and a blue-money price. Every Alienstani has two incomes – a red
income and a blue income.

In order to buy an object, an Alienstani has to pay that object’s red money price in red money and its
blue money price in blue money. It is forbidden to trade one kind of money for the other, and this
prohibition is strictly mandated by Alienstan’s strict and ruthless monetary police.

 There are just two consumer goods on Alienstan, chocolates and ice creams. All Alienstanis
prefer more of each good to less.
 The blue prices are 1 blue currency unit (bcu) per unit of chocolate and 1 bcu per unit of ice
cream.
 The red prices are 2 red currency units (rcu-s) per unit of chocolate and 6 rcu-s per unit of ice
cream.
(a) Draw the red budget and the blue budget for an Alienstani named Ken whose blue income is 10
and red income is 30. Shade in the budget set containing all of the commodity bundles that Ken
can afford, given its two budget constraints. Remember, Ken has to have enough blue money and
enough red money to pay both the blue money cost and the red money cost of a bundle of goods.
(b) Another Alienstani, Gigi faces the same prices that Ken faces and has the same red income as that
of Ken, but Gigi has a blue income of 20. Explain how it is that Gigi will not spend its entire blue
income no matter what its tastes may be.
(c) A group of radical economists on Alienstan believe that the currency rules are unfair. “Why should
everyone have to pay two prices?”, they ask. They propose the following scheme:
Alienstan will continue to have two currencies, every good will have a blue price and a red price,
and every Alienstani will have a blue income and a red income. But nobody has to pay both prices.
Instead, everyone on Alienstan must declare itself to be either a Blue-Money Purchaser (Blue) or
a Red-Money Purchaser (Red) before it buys anything at all. Blues must spend all of their
 purchases in blue money at the blue prices, spending only their blue incomes. Reds must make all
of their purchases in red money, spending only their red incomes.
Suppose Ken has the same income after the reform, and that the prices do not change. Before
declaring which kind of purchaser it will be, Ken contemplates the set of commodity bundles it
could afford by making one declaration or the other. Let us call a bundle “attainable” if Ken can
afford it by declaring itself to be a Blue and buying the bundle with blue money or if Ken can afford
the bundle by declaring itself to be a Red and buying it with red money. Draw separate blue and
red budget lines and show the attainable space.
(d) Are Alienstani budgets really so fanciful? Can you think of situations on Earth where people must
simultaneously satisfy more than one budget constraint? Is money the only scarce resource that
people use up when consuming?

Question 2

Raman is preparing for exams in Economics and Physics. He has time to read 40 pages of Economics
and 30 pages of Physics. In the same amount of time, he could also read 30 pages of Economics and
60 pages of Physics.

(a) Assuming that the number of pages per hour that he can read of either subject does not depend
on how he allocates his time, how many pages of physics could he read if he decided to spend all
his time on physics and none on economics?
(b) How many pages of economics could he read if he decided to spend all of his time reading
economics?

Chapter 3
Payel is happiest when she has 8 cookies and 4 glasses of milk per day. Whenever she has more than
favourite amount of either food, giving her still more makes her worse off. Whenever she has less than
her favourite amount of either food, giving her more makes her better off. Her mother makes her drink
7 glasses of milk and only allows her 2 cookies per day. One day when her mother was gone, Payel’s
sadistic brother made her eat 13 cookies and gave her only 1 glass of milk, despite the fact that Payel
complained bitterly about the last 5 cookies that he made her eat and begged for more milk. Although
Payel complained later to her mother, she had to admit that she liked the diet that her brother forced
on her better than what her mother demanded.

(a) Draw some Indifference curves for Payel that are consistent with this story.
(b) Payel’s mother believes that the optimal amount for her to consume is 7 glasses of milk and 2
cookies. She measures deviations by absolute values. If Payel consumes some other bundle
say (𝑐, 𝑚), she measures his departure from the optimal bundle by 𝐷 = |7 − 𝑚 | + |2 − 𝑐|.
The larger 𝐷 is, the worse off she thinks Payel is. Sketch some of Payel’s mother’s indifference
curves for Payel’s consumption.

Chapter 4
Question 1

Charlie consumes apples and bananas. Charlie’s utility function happens to be U(xa,xb) = xaxb.
(a) Charlie has 40 apples and 5 bananas. Charlie’s utility for the bundle (40, 5) is U(40, 5) = ______.
The indifference curve through (40, 5) includes all commodity bundles (xa,xb) such that xaxb = ____.
 So the indifference curve through (40, 5) has the equation x b = (200/ xa) . Draw the indifference
curve showing all of the bundles that Charlie likes exactly as well as the bundle (40, 5).
(b) Donna offers to give Charlie 15 bananas if he will give her 25 apples. Would Charlie have a bundle
that he likes better than (40, 5) if he makes this trade? _______. What is the largest number of
apples that Donna could demand from Charlie in return for 15 bananas if she expects him to be
willing to trade or at least indifferent about trading? ______.(Hint: If Donna gives Charlie 15
bananas, he will have a total of 20 bananas. If he has 20 bananas, how many apples does he need
in order to be as well-off as he would be without trade?)

Question 2

Shirley thinks a 16-ounce can of beer is just as good as two 8-ounce cans. Lorraine only drinks 8 ounces
at a time and hates stale beer, so she thinks a 16-ounce can is no better or worse than an 8-ounce can.

(a) Write a utility function that represents Shirley’s preferences between commodity bundles
comprised of 8-ounce cans and 16-ounce cans of beer. Let X stand for the number of 8-ounce cans
and Y stand for the number of 16-ounce cans.

(b) Now write a utility function that represents Lorraine’s preferences.

(c) Would the function utility U(X,Y ) = 100X+200Y represent Shirley’s preferences? Would the utility
function U(x,y) = (5X + 10Y )2 represent her preferences? Would the utility function U(x,y) = X + 3Y
represent her preferences?

Chapter 5
Question 1

The telephone company allows one to choose between two different pricing plans. For a fee of $12
per month, you can make as many local phone calls as you want, at no additional charge per call.
Alternatively, you can pay $8 per month and be charged 5 cents for each local phone call that you
make. Suppose that you have a total of $20 per month to spend.

(a) Draw a budget line for someone who chooses the first plan. Draw a budget line for someone who
chooses the second plan. Where do the two budget lines cross?
(b) Draw indifference curves for someone who prefers the second plan to the first. Draw an
indifference curve for someone who prefers the first plan to the second.

Question 2

Elmer’s utility function is U(x,y) = min{x,y2}.

(a) If Elmer consumes 4 units of x and 3 units of y, his utility is ________.

(b) If Elmer consumes 4 units of x and 2 units of y, his utility is _________.

(c) Draw the indifference curve for Elmer that contains the bundles that he likes exactly as well as the
bundle (4, 2). Draw the indifference curve for Elmer that contains bundles that he likes exactly as well
as the bundle (1, 1) and the indifference curve that passes through the point (16, 5).
(d) Show the locus of points at which Elmer’s indifference curves have kinks. What is the equation for
this curve? Draw Elmer’s budget line when the price of x is 1, the price of y is 2, and his income is 8.
What bundle does Elmer choose in this situation?

Chapter 6:
Question 1:

Douglas Cornfield’s preferences are represented by the utility function u(x1,x2) = x12 x23. The prices of
x1 and x2 are p1 and p2.

(a) The slope of Cornfield’s indifference curve at the point (x1,x2) is _______.

(b) If Cornfield’s budget line is tangent to his indifference curve at (x1,x2), then { p1 x1/ p2 x2} = ______.
(Hint: Look at the equation that equates the slope of his indifference curve with the slope of his budget
line.) When he is consuming the best bundle he can afford, what fraction of his income does Douglas
spend on x1?

(C) Other members of Doug’s family have similar utility functions, but the exponents may be different,
or their utilities may be multiplied by a positive constant. If a family member has a utility function
U(x,y) = c x1a x2b where a, b, and c are positive numbers, what fraction of his or her income will that
family member spend on x1?

Question 2: (MCQ)
Miss Muffet insists on consuming 2 units of whey per 1 unit of curds. If the price of curds is $5 and the
price of when is $6, then if Miss Muffet’s income is m, her demand for curds will be-
a.5c+6w = m.
b. 6m/5.
c. 5m.
d. m/5.
e. m/17

Question 3: (MCQ)

Between 1990 and 2000, a par tic u lar consumer’s income increased by 25%, while the price of X and
of “all other goods” both increased by 10%. It was observed that the consumer’s consumption of X
and of all other goods both increased by 15%.
a. The consumer did not regard X and “all other goods” as perfect complements.
b. The consumer’s preferences cannot be represented by a Cobb- Douglas utility function.
c. The consumer’s preferences can be represented by a Cobb- Douglas utility function.
d. The consumer’s preferences cannot be represented by a quasilinear utility function.
e. More than one of the above options is true

Chapter 8
Question 1:
Agatha must travel on the Orient Express from Istanbul to Paris. The distance is 1,500 miles. A traveler
can choose to make any fraction of the journey in a first-class carriage and travel the rest of the way
in a second-class carriage. The price is 10 cents a mile for a second-class carriage and 20 cents a mile
for a first-class carriage. Agatha much prefers first-class to second-class travel, but because of a
misadventure in an Istanbul bazaar, she has only $200 left with which to buy her tickets. Luckily, she
still has her toothbrush and a suitcase full of cucumber sandwiches to eat on the way. Agatha plans to
spend her entire $200 on her tickets for her trip. She will travel first class as much as she can afford
to, but she must get all the way to Paris, and $200 is not enough money to get her all the way to Paris
in first class.

(a) On the graph below, use red ink to show the locus of combinations of first- and second-class tickets
that Agatha can just afford to purchase with her $200. Show the locus of combinations of first and
second-class tickets that are sufficient to carry her the entire distance from Istanbul to Paris.
Locate the combination of first- and second-class miles that Agatha will choose on your graph and
label it A.
(b) Let m1 be the number of miles she travels by first-class coach and m2 be the number of miles she
travels by second-class coach. Write down two equations that you can solve to find the number
of miles she chooses to travel by first-class coach and the number of miles she chooses to travel
by second-class coach.
(c) The number of miles that she travels by second-class coach is _______.
(d) Just before she was ready to buy her tickets, the price of second-class tickets fell to $.05 while the
price of first-class tickets remained at $.20. Show the combinations of first-class and second-class
tickets that she can afford with her $200 at these prices. Locate the combination of first-class and
second-class tickets that she would now choose. (Remember, she is going to travel as much first-
class as she can afford to and still make the 1,500-mile trip on $200.) Label this point B. How many
miles does she travel by second class now? (Hint: For an exact solution you will have to solve two
linear equations in two unknowns.) Is second-class travel a normal good for Agatha? Is it a Giffen
good for her?

Question 2: (MCQ)

Suppose that bananas are a normal good and Woody is currently consuming 100 bananas at a price
of 10 cents each.
a. His Slutsky compensated demand curve going through this point is steeper than his ordinary
demand curve.
b. His ordinary demand curve going through this point is steeper than his Slutsky compensated
demand curve.
c. His ordinary demand curve is steeper to the left and his Slutsky compensated demand curve is
steeper to the right of this point.
d. Whether his ordinary demand curve or his Slutsky compensated demand curve is steeper depends
on whether his price elasticity is greater than 1.

Question 3: (MCQ)

Polly consumes crackers and fruit. The price of fruit rose and the price of crackers stayed constant.
The income effect on Polly’s demand is
a. zero because Polly’s income didn’t change.
b. the change in Polly’s demand if her income is decreased by the change in the price of fruit times
her old consumption of fruit.
c. The change in Polly’s demand if her income is decreased by the total amount she used to spend on
fruit.
d. the change in Polly’s demand if her income is increased by the amount she used to spend on fruit
Q1

Lucetta consumes only two goods, A and B. Her only source of income is gifts of these commodities
from her many admirers. She doesn’t always get these goods in the proportions in which she wants
to consume them in, but she can always buy or sell A at the price 𝑝𝐴 = 1 and B at the price 𝑝𝐵 = 2.
Lucetta’s utility function is 𝑈(𝑎, 𝑏) = 𝑎𝑏, where a is the amount of A she consumes and b is the
amount of B she consumes.

(a) Suppose that Lucetta’s admirers give her 100 units of A and 200 units of B. Draw her budget line.
Label her initial endowment E.
(b) What are Lucetta’s gross demands for A? And for B?
(c) What are Lucetta’s net demands?
(d) Suppose that before Lucetta has made any trades, the price of good B falls to 1, and the price of
good A stays at 1. Draw Lucetta’s budget line at these prices.
(e) Does Lucetta’s consumption of good B rise or fall? It rises. By how much? What happens to
Lucetta’s consumption of good A?
(f) Suppose that before the price of good B fell, Lucetta had exchanged all of her gifts for money,
planning to use the money to buy her consumption bundle later. How much good B will she choose
to consume? How much good A?
(g) Explain why her consumption is different depending on whether she was holding goods or money
at the time of the price change.

Q2

Dudley’s utility function is U(C, R) = C − (12 − R)2 , where R is the amount of leisure he has per day.
He has 16 hours a day to divide between work and leisure. He has an income of $20 a day from
nonlabor sources. The price of consumption goods is $1 per unit.
(a) If Dudley can work as many hours a day as he likes but gets zero wages for his labor, how many
hours of leisure will he choose?
(b) If Dudley can work as many hours a day as he wishes for a wage rate of $10 an hour, how many
hours will he choose to work? (Hint: Write down Dudley’s budget constraint. Solve for his labor
supply. Remember that the amount of labor he wishes to supply is 16 minus his demand for
leisure.)
(c) If Dudley’s non-labor income decreased to $5 a day, how many hours would he choose to work?
(d) Suppose that Dudley has to pay an income tax of 20 percent on all of his income, and suppose
that his before-tax wage remained at $10 an hour and his before-tax non-labor income was $20
per day; how many hours would he choose to work?

Q3

Felicity loves her job. She is paid $10 an hour and can work as many hours a day as she wishes. She
chooses to work only 5 hours a day. She says the job is so interesting that she is happier working at
this job than she would be if she made the same income without working at all. A sceptic asks, “If you
like the job better than not working at all, why don’t you work more hours and earn more money?”
Felicity, who is entirely rational, patiently explains that work may be desirable on average but
undesirable on the margin. The sceptic insists that she show him her indifference curves and her
budget line.
(a) On the axes below, draw a budget line and indifference curves that are consistent with Felicity’s
behaviour and her remarks. Put leisure on the horizontal axis and income on the vertical axis.
(Hint: Where does the indifference curve through her actual choice hit the vertical line l = 24?)

Q4
(1−α)
Molly has a Cobb-Douglas utility functionU(c1 , c2 ) = c1α 𝑐2 , where 0 <α< 1 and where 𝑐1 and 𝑐2
are her consumptions in periods 1 and 2 respectively. We saw earlier that if utility has the form
(1−𝛼)
𝑈(𝑥1 , 𝑥2 ) = 𝑥1α 𝑥2 and the budget constraint is of the “standard” form 𝑝1 𝑥1 + 𝑝2 𝑥2 = 𝑚, then the
demand functions for the goods are 𝑥1 = α𝑚/𝑝1 and 𝑥2 = (1 − α)𝑚/𝑝2 .

(a) Suppose that Molly’s income is 𝑚1 in period 1 and 𝑚2 in period 2. Write down her budget
constraint in terms of present values.
(b) We want to compare this budget constraint to one of the standard forms. In terms of Molly’s
budget constraint, what is 𝑝1? What is 𝑝2? What is m?
(c) If α = .2, solve for Molly’s demand functions for consumption in each period as a function of
𝑚1 , 𝑚2 , 𝑎𝑛𝑑 𝑟. Her demand function for consumption in period 1 is 𝑐1 = .2𝑚1 +
.2𝑚2 /(1 + 𝑟). Her demand function for consumption in period 2?
(d) An increase in the interest rate will ………….? her period-1 consumption. It will ………? her
period-2 consumption and ………..? her savings in period 1.

Q5

Mr. O. B. Kandle will only live for two periods. In the first period he will earn $50,000. In the second
period he will retire and live on his savings. His utility function is 𝑈(𝑐1 , 𝑐2 ) = 𝑐1 𝑐2 , where 𝑐1 is
consumption in period 1 and 𝑐2 is consumption in period 2. He can borrow and lend at the interest
rate r=.1

(a) If the interest rate rises, will his period-1 consumption increase, decrease or remain the same?
(b) Would an increase in the interest rate make him consume more or less in the second period?
(c) Mr. Kandle’s income is zero in period 1, and $ 55,000 in period 2, would an increase in the
interest rate make him consume more, less, or the same amount in period 1?

Q6
2
The demand function for drangles is 𝑞(𝑝) = (𝑝 + 1)− .

(a) What is the price elasticity of demand at price p?

(b) At what price is the price elasticity of demand for drangles equal to −1?
(c) Write an expression for total revenue from the sale of drangles as a function of their price. Use
calculus to find the revenue-maximizing price. Don’t forget to check the second-order
condition.
(d) Suppose that the demand function for drangles takes the more general form 𝑞(𝑝) =
(𝑝 + 𝑎)(−𝑏) where a > 0 and b > 1. Calculate an expression for the price elasticity of demand
at price p. At what price is the price elasticity of demand equal to −1?

Q7

Ken’s utility function is 𝑢𝐾 (𝑥1 , 𝑥2 ) = 𝑥1 + 𝑥2 and Barbie’s utility function is 𝑢𝐵 (𝑥1 , 𝑥2 ) =

(𝑥1 + 1)(𝑥2 + 1). A person can buy 1 unit of good 1 or 0 units of good 1. It is impossible for anybody
to buy fractional units or to buy more than 1 unit. Either person can buy any quantity of good 2 that
he or she can afford at a price of $1 per unit.
 (a) Where m is Barbie’s wealth and 𝑝1 is the price of good 1, write an equation that can be solved
to find Barbie’s reservation price for good 1. What is Barbie’s reservation price for good 1?
What is Ken’s reservation price for good 1?
(b) If Ken and Barbie each have a wealth of 3, plot the market demand curve for good 1.

Q8

For each of the following demand curves, compute the inverse demand curve.
(a) 𝐷(𝑝) = 𝑚𝑎𝑥{10 − 2𝑝, 0}.
(b) 𝐷(𝑝) = 100/ √𝑝
(c) 𝑙𝑛 𝐷(𝑝) = 10 − 4𝑝
(d) 𝑙𝑛 𝐷(𝑝) = 𝑙𝑛 20 − 2𝑙𝑛 𝑝

CV and EV
Consider a person who consumes two commodities x and y and has utility function

u(x, y) = x + y – (1/2)y2

Let good x be the numeraire and consider price vectors of the form p = (1, py) where py is the price of
good y.

a. For what price-income combinations does this consumer choose to consume positive
amounts of both goods. For price income combinations such that he consumes positive
amounts of each good, write an equation for this person’s Marshallian demand function for
each good.
b. Let v(1, py , m) be this person’s indirect utility function at price vector (1, py) and income m.
Write an equation for v(1, py, m) that applies at all price-income situations such that he
chooses some of each good. Write your equation in as simple a form as possible.
c. Suppose that this consumer initially consumes positive amounts of both goods at income m
and prices (1, py ). The prices change to (1, py ‘ ). Solve for the compensating variation of this
price change. Solve for the equivalent variation of this price change. Show that compensating
and equivalent variation are equal.

Monopoly
Question 1

The total cost function for a monopolist’s output 𝑋 is 𝐶 = 6𝑋 + 0.05𝑋 2 and the demand function is
given by 𝑋 = 360 − 2𝑃.

a) Calculate the price, quantity produced and the monopolist’s profits.

b) The government wishes to impose maximum price at a level that will induce the monopolist
to produce the maximum possible output. What is the price, how much output will be
produced, and what shall be the profit of the monopolist?
c) What are the break-even output and price levels, that is, the output and price level if the
monopoly firm is regulated under the average price regulation?

Question 2

A monopolist produces a good using the cost function, 𝐶 = 𝛼𝑥, 𝛼 > 0. There is an ad-valorem tax on
the price of the good such that when the consumer pays 𝑝, the monopolist receives 𝑝1 = (1 − 𝛼 )𝑝,
0 < 𝛼 < 1. As an alternative to the ad valorem tax, consider a quantity tax 𝑡 on output such that 𝑝′ =
𝑝 + 𝑡. The elasticity of the market demand curve is constant. Determine the value of 𝑡 such that the
final pricing shall be the same under the two tax regimes.

Question 3

A monopolist produces a product from two plants (A and B) and sells the product in two markets (1
and 2). The average cost levels are such that it is always profitable to produce. The two cost functions
and the market demand functions are as follows:
2𝑋𝐴 2
𝐶𝐴 = − 12 𝑋𝐴 and 𝐶𝐵 = 2𝑋𝐵 2 + 36𝑋𝐵
3

𝑋1 = 300 − 𝑝1 and 𝑋2 = 180 − 𝑝2

Consider each of the following cases and answer the questions:

a) The monopolist can charge only one price, that is the same price is charged in both markets.
i) How much does the monopolist produce from the plants A and B?
ii) How much does it sell in the two markets?
b) The monopolist follows a third degree price discrimination.
i) How much does it produce from the plants A and B?
ii) How much does it sell in the two markets?
iii) What are the prices in the markets 1 and 2?
iv) Does the monopolist earn a higher profit now than under case a)? Demonstrate your
claim.
c) The monopolist follows first degree price discrimination.
i) How much does he produce from plants A and B?
ii) How much does he sell in the two markets?
iii) Compare the profits with that of case a).

Quesstion 4

A monopoly firm in country A produces a good using the cost function 𝐶 = 0.025𝑋 2 + 45𝑋 +
400000. The good is sold in countries A and B, where the latter is the only export market. The demand
curves in the two countries are 𝑝𝐴 = 744 − 0.3𝑋𝐴 and 𝑝𝐵 = 400 − 0.3𝑋𝐵 . The exchange ratio
between the currencies in the two countries A and B is 1: 2.

Country A imposes a sales tax of 20% of the retail price of the product. There is no sales tax in country
B, but there is flat import duty of 15 units of money per unit of output. Transport costs to country B
are 50 units of money per unit of output.

The producer is a profit maximiser. Determine the

(a) The price in country A, before sales tax

(b) Volume of sales in country A
(c) Price in country B
(d) Volume of sales in country B
(e) Tax receipts from sales tax in country A
(f) Tax receipts from import duty in country B
(g) Revenue of the transport company
(h) Producer’s profits
_______________