Intermediate Microeconomics Problems

Budget Constraint:
1. A certain phone company charges its clients a fixed amount of 30 € per month.
This payment allows 30 minutes of conversation free of charge per month. Above 30
minutes additional calls are charged at 0.15 € per minute.
a) Represent graphically and analytically the budget constraint of a
representative consumer who has an income of M € to spend on call minutes
(T) and on a composite good (C) which costs 1 €.
b) Suppose that the company evaluates two alternative price schemes:
i. Decrease from 30 to 20 the amount of minutes free of charge per
month (with a price of 0.15 € per additional minute call)
ii. Increase the price of each minute call to 0.2 € (with 30 minutes free of
charge)
Represent graphically the correspondent budget constraints. Can you say anything
about the type of customers that will prefer tariff i.? And who will prefer tariff ii?

Preferences:
2. Suppose that your preferences can be represented by the following utility
function: U ( x1 ; x 2 ) = x1 x 2 .
a) Suppose that the initial consumption bundle of this consumer is (x1 ; x2 ) = (4;3).
If instead of 3 units of good 2 you now decide to consume 8 units of this good,
what is the consumption of good 1 that gives you the same utility?
b) Calculate the MRS1, 2 (x1 ; x 2 ) . Explain the effect on the Marginal Rate of
Substitution of an increase on the consumption of good 1.
c) Answer again question b) assuming that your utility function is now given by:
U (x1 ; x 2 ) = x1 + ln (x 2 ) .
d) The following table describes the utility functions of your friends. Identify
those who have the same preferences as you and justify.

Valerie V (x1 ; x 2 ) = 1000 x1 x 2

Walt W (x1 ; x 2 ) = − x1 x 2

1
Zack Z (x1 ; x 2 ) = −
x1 x 2 + 1

Frank F (x1 ; x 2 ) = x1 x 2 − 10000

x1
Gun-woo G(x1 ; x 2 ) =
x2

Ha-eun H (x1 ; x 2 ) = x1 (x 2 + 1)
Optimal Choice / Demand Functions:
3. Consider a consumer who has 500€ of income to spend in Food (F) and Trips (T). His
preferences are well described by the following utility function:
U(F;T) = ln(F) + T
a) Formalize the problem of this consumer and determine his demand functions.
b) Each meal costs 10€ and each trip costs 600€. What is the optimal choice of F
and T for this consumer?
Assume now that each trip costs 300€.
c) Determine the new choice.
d) The price of each meal decreases to 5€. Determine the change on his optimal
choice using only your intuition, i.e., without doing no any calculations or
graphics. Justify

4. (You can skip this) A certain consumer with well-behaved preferences spends $300
per month on the consumption of two goods, x1 and x2. The prices of these two goods
are P1 =20 and P2=25, respectively. At these prices his consumption bundle is x1 =
7,5; x2= 6.
a) Represent graphically the initial equilibrium.
Assume that the price of good 1 decreases to P1 = 15. The new equilibrium can be
alternatively:
A: x1 = 7,5 ; x2= 7,5
B: x1 = 12,5 ; x2= 4,5
b) Classify good 1 considering that the new equilibrium is bundle A. If the
individual chooses allocation B instead, how do you classify goods 1 and 2?
c) Represent the demand curve for good 1 (considering equilibrium A) with the
available information. Repeat the exercise for the other equilibrium.

5. Consider that a Korean consumer, Gun-woo, loves fruit juice. However, he cannot
distinguish between the Apple juice (A) and the Cherry juice (C). He is indifferent
between the consumption of one can of A and one can of C.
a) Propose a utility function representing Gun-woo’s preferences.
b) Assume that Gun-woo spends 30 € on the consumptions of these two goods. If
the price of each unit of A is 2 € and C costs 1 € per unit, what is the optimal
choice of A and C? Represent graphically and provide an economic intuition
of this choice.
c) Represent the Engel curves for both goods.
d) Suppose that the price of C is now 1.5 €. Determine the optimal choice under
this new situation.
6. Consider a representative consumer of a country, who spends his income on the
consumption of oil, G, and other goods, X. The preferences for G and X can be
described by the following utility function:

U (G; X ) = G 0.2 X 0.8

His income is 1000 €. Each unit of oil costs 2 € and the price of other goods is 1 € per
unit.
a) Without doing any calculations indicate his expenditure on goods G and X.
Justify
b) State the demand functions for G and X. Determine the optimal choice.
c) Suppose that the government needs to increase revenues and decides to
introduce a tax on oil of 2 € per unit. Determine the revenue collected with
this tax.
d) Show graphically and analytically that an income tax yielding the same
revenue allows this consumer to attain a higher utility level than this tax on
the price of the good.

7. Consider again the consumers of the same country who have an utility represented by
the function:

U (G; X ) = G 0.2 X 0.8 where G represents units of oil and X units of a composite good.
Assume that the representative consumer decides to spend 1000 € on the purchase of
the two goods. The price of each unit of oil is 2€ and each unit of the composite good
costs 1 €. More recently, due to a reduction in the extraction of oil by OPEC countries,
the price of G increased to 4 €.

a) Quantify the impact of the increase in the price of oil on the optimal choice.
Justify.
b) The government is worried with the welfare reduction caused by this price
increase, and decides to give a lump-sum subsidy to each consumer. The
Ministry of Finance states, “The subsidy will be calculated such that
consumers could consume the same amounts of goods X and G as before”.
i. Calculate the amount of subsidy.
ii. Relate the attributed subsidy with the welfare measures that you know.
c) Will consumers choose the initial allocation after the increase in the price of
oil? Justify.
d) Suppose now that a deputy from the opposition political party states that: “the
amount of subsidy given by the government over-compensates these
consumers for the increase in price”. Do you agree? Justify your answer
computing the amount of this “excess”.
e) Under what conditions would the deputy statement in question d) be wrong?
Explain.
8. Consider the utility function of question 5 for Gun-woo, loves fruit juice but cannot
distinguish between the Apple juice (A) and the Cherry juice (C). M = 30, PA = 2, and
PC = 1.

a) Suppose that the price of each unit of C increases to 1,5 €. Decompose the
variation of the quantity demanded in Hicks’ substitution and income effects.
Justify your answer and interpret the result.
b) The producer of C is concerned with the prospect of loosing clients due to the
increase in the price of this drink. Consequently, he gives each consumer the
minimum subsidy required to grant each client the initial level of utility. What
is the amount of this subsidy? Interpret the result obtained and relate it with
the compensating variation concept.
c) After the attribution of the subsidy, do you think that the quantity sold remains
unchanged? Justify your answer.

9. Suppose that Jisoo enjoys eating strawberries (s) with cream (c) during her working
hours. She affects 36 € of her income to the consumption of these goods. Her
preferences are well described by the following utility function:

U(s,c) = min{s;2c}
where s represents kg of strawberries and c stands for units of cream.

a) Determine the optimal choice if the price of s is 4 € per kg and each unit of
cream costs 1 €. Represent it graphically.
b) Determine the demand curve for strawberries.

Jisoo buys cream only from a shop in the neighborhood. Suppose that when the shop
is closed, she has to order cream from the Internet, where the price is 4 € per spoon.

c) What will her optimal choice be? Decompose this change in Hicks’
substitution and income effects. Represent graphically this decomposition.
d) What about Slutsky’s substitution and income effects?
e) Determine the impact of this change on the demand for strawberries.

10. Consider again the consumer in question 3, who has 500€ of income to spend in Food
(F) and Trips (T). His preferences are well described by the following utility function:
U(F;T) = ln(F) + T
Initially the price for F was 10 € and suppose it decreases to 5€. Show only
graphically the change in Hicks’ substitution and income effects.
a) For the price of T being €600.
b) For the price of T being €300.
 Producer Theory / Cost Function:
11. Consider the following graph and answer the following questions:
a) At A, the marginal rate of technical substitution is 1. If the price of L is 10, what is
the price of K? And what is the quantity of K used at A? Justify.
b) Suppose that in the short run K = 8. Calculate the variable costs in the short run of
producing Y = 75.
c) What is the long run average cost of producing Y=75? Justify.
d) What is the production at B, if the production function exhibits constant returns to
scale? Justify.

24

B
?

Y=?
A
?
Y=75

Y=50

8 16 21 L
12. A firm uses capital and labor according to the following production function:
f ( L; K ) = 2 L + K , where L and K represent labor and capital, respectively.
a) Suppose that PL=1 and PK =2 and determine the expansion path.
b) Determine the conditional demand functions for both inputs.
c) Suppose that the firm has to rent a building at a price of 100 € to produce. Derive the
cost function of this firm given the prices of K and L in a).

13. Formally demonstrate the following sentences:

a) “The marginal cost curve intercepts the average variable cost curve and the average
total cost curve at their respective minima”.
b) “If the long run average cost is increasing with output then this production function
has decreasing returns to scale.”

14. Consider the short run cost functions of a firm that can be described by:

C(Y,K) = 0,04Y3 – 0,9Y2 + (11-K)Y + 5K2

where K represents the level of installed capacity.

a) Represent the short run average and marginal cost functions.

b) Determine the long run cost function.
c) Suppose that the market price is exogenous to this firm and equal to P=4. Determine
the optimal level of production, the optimum installed capacity and the profit of this
firm.
d) If the price increases to P=6 what would be, for this firm, the new production level,
installed capacity and profit?

Perfect Competition
15. The domestic market demand function for a given homogeneous good is Y = 6000-1000P.
This good is provided both by domestic and international producers. The domestic production
is ensured by 100 identical firms that are price-takers. Each firm has an individual total cost
 function given by: TC ( y ) = 0.1 y 2 + y + 10 , where y is the quantity produced. Each

international producer has a constant marginal cost of 3 € and can freely enter in the domestic
market to sell its product.

a) Derive the total supply curve (i.e. domestic production and imports) for this market.
b) Determine the market equilibrium (price and quantity), the quantity produced by each
domestic firm, the correspondent profits and imports.

Suppose that the national authorities were induced by domestic producers to introduce a tax
on imports of 1 €. per unit.

c) Calculate the new market equilibrium.

d) Identify clearly the gains and losses of each group (domestic producers, government,
consumers). Does the introduction of this tax benefit the national economy? Justify.

16. Korean pear market is composed by 100 firms with the same cost structure. Each firm uses
0.5
two inputs, T and L, and the technology can be described by: y i = 2(Li Ti ) + Ti , where yi
represents tons of pears produced by firm i. In the short-run, T is fixed (T=4) and the price of
inputs T and L is 2€ and 4€, respectively.

a) Derive the short-run supply function for a representative firm and draw it.
b) Derive the aggregate supply.

Consider that the demand for pear is given by: YD = 2000 − 200 P .

c) Determine the market equilibrium (price and quantity), each firm’s production level
and profits.

Assume that there are 100 Japanese firms that can also provide pear to the Korean market.
The Japanese supply function is given by Ys = 200 P + 400 .
 d) If these Japanese firms can freely sell oranges in Korea, what will be the new
equilibrium?
e) Discuss graphically and analytically the welfare impact of this entrance both on
national consumers and producers.

Monopoly and Price discrimination

17. The demand curve for a given product is given by y = 50-p . The only firm that produces

this product has a cost function given by C ( y ) = 20 y + 5.

a) Obtain the optimal quantity, market price and profit for this firm. Illustrate
graphically your answer.
b) What would be the quantity produced, price(s) and profit if this firm could do first
order price discrimination? Illustrate graphically your answer. In this case would we
have market efficiency? Justify your answer.
c) Assume now that this firm cannot perfectly price discriminate because it doesn’t
known the individual demand function of the consumers. A consulting firm proposes
to sell this information to the monopolist. What is the maximum amount that this firm
is willing to pay for this information? Justify your answer.
d) Is this firm a natural monopolist? Explain your answer.

18. In 1960, only one doctor was working in Island of Jeju. This doctor could attend one person
per hour and had a maximum of 40 working hours per week. The demand for his private
clinic (pc) was given by: P = 100 − Y , where Y is the number of consultations per week.

a) Determine the price that the doctor would charge per consultation in his private clinic
assuming that the costs of providing this service did not depend on the number of
clients. Justify.

Suppose that in 1964 a National Health Service (nhs) was created to provide the same service
to poor people that could not afford private clinic. The doctor was paid 40 € per consultation
at the nhs.
 b) Calculate the new price per private consultation assuming that the costs of providing
this service did not depend on the number of clients either at pc or nhs.
c) Suppose now that at nhs the doctor has costs of 10 € per consultation associated with
bureaucratic load (assume constant fixed costs for pc). What will be, in this situation,
the price per consultation at pc
d) Consider the inverse situation in which a pc consultation has a variable costs of 10 €
per consultation and there is no cost associated with consultations at nhs. What will
be the price per pc consultation?

Oligopoly
In 1970 a Korean doctor who lived in USA came to Island of Jeju to work on private practice.
Assuming that this new doctor had the same conditions as the resident one answer the
following questions.
e) Determine the number of consultations and the correspondent prices charged by each
private doctor under Stackelberg competition (the old doctor was the leader)
f) What would happen if both doctors decided to share the same private clinic? Justify.
g) Determine the consumer surplus of the previous two solutions and state an efficiency
argument against collusion.

19. Two young competing managers are planning to sell “T-shirts” during a rock concert. The
demand for this good is given by: P = 10 − Y . In order to sell these T-shirts, they have to
order them previously, at a 1 € cost per unit.
a) What type of duopoly model is appropriate to describe this situation? Justify.
b) Calculate the quantity that was previously ordered by each manager under conditions
of question a). Can you provide an estimate of the price per T-shirt in the day of the
concert? Justify.
c) Suppose that the managers were required by the organizers of the concert to reveal
the price of each T-shirt before the concert. In your opinion would the price obtained
in question b) remain the same? If not, how many T-shirt would be sold and at what
price? Justify.
d) Assume that the two managers can only collude or compete à la Cournot . Discuss
the possible outcomes of this simultaneous game. Is the situation described a
prisoner’s dilemma? Explain.
 Monopolistic Competition
20. Consider a market of monopolistic competition with 101 firms with identical demand and
cost functions given by:
101
PK = 150 − Q K − 0,02 ∑Q , i K = 1,.....,101
i =1
i≠K

C K = 0,5Q K3 − 20Q K2 + 270Q K , K = 1,.....,101

a) Suppose initially that we are in the short run and so the number of firms in the market
is fixed. Obtain the equilibrium for a representative firm in the short run: profits,
price and quantity produced.
b) Suppose now that we are in the long run and so there is free entry/ exit of firms. In
this case, what is the market equilibrium?