ECON 10000: Principles of Microeconomics

Spring 2025

Problem Set 2

Due Wednesday April 16, 11:59pm

Please follow the graders’ instruction regarding submission via

Please type your problem set! (You can insert hand drawn figures as images)

Note: you can form groups of 5 people maximum and you should turn in one problem set per
group.
1. Jennifer’s demand curve for beer is given by: 𝑝 = 8 − 𝑞! and Lawrence’s demand curve for
beer is given by: 𝑝 = 4 − 2𝑞" . [15 TOTAL POINTS] OPTIONAL (SOLUTIONS WILL BE PROVIDED
BUT NOT GRADED)

a. Assuming that Jennifer and Lawrence are the only consumers in the market, graphically find
the market demand curve. The graph does not need to be in scale, but make sure to label all
relevant intercepts and key features. [5 points]

b. The market supply for beer is given by: 𝑝 = 2𝑞 − 2. Algebraically, find the equilibrium
quantity and price. Assume consumers can purchase partial quantities. (Hint: before you do
any math, think about the solution graphically!) [5 points]

c. Are you able to tell the individual beer consumption levels for Jennifer and Lawrence? If so,
find them. If not, explain why you cannot find them. [5 points]

2. In this question, we will analyze the optimization problem of a consumer but the budget
constraint will not be a “straight” line like the one we saw in class. The consumer derives utility
from consuming only food (F) and housing (H) and their corresponding prices are 𝑝# = $2 and
𝑝$ = $50. The consumer’s income is $500. [35 TOTAL POINTS]

a. First, let’s make sure we understand the basic concepts learned in class. With H on the x-
axis and F on the y-axis, draw the consumer’s budget constraint. Make sure you label all
intercepts and the slope. Also, make it big enough as we will use it later. [2 points]

b. You are told that the preferences of the consumer can be represented by the standard
convex (crescent shaped) indifference curves. You are also told that the optimal bundle of
this consumer is 𝐹 = 125 and 𝐻 = 5. On the graph in a., draw the indifference curve that
includes such an optimal bundle. [2 points]

c. Graphically, at the optimal consumption bundle, the budget constraint is tangent to the
indifference curve. (i) What’s the mathematical condition that holds at the optimal
consumption bundle? (ii) And most importantly, what’s the economic interpretation of that
condition? [5 points]

d. As a policy to fight against obesity, the government implements the following pricing for
food: the price of food is $2 for the first 125 units, after which the price rises to $5.
Replicate the graph in a., draw the new budget constraint. Make sure you label all
intercepts and slope. [3 points]

e. What will the optimal consumption bundle be after the government’s intervention? Justify
your answer. [3 points]
f. At the optimal consumption bundle in part e., does the mathematical condition for
optimality in part c. (i) hold here? Justify your answer. [3 points]

g. Draw the budget constraints and indifference curves for a different consumer for whom the
government intervention negatively affects his/her utility. You can assume that this
consumer still has convex indifference curves. [3 points]

h. Draw the budget constraints and indifference curve/s for a different consumer for whom
the government intervention leaves him/her indifferent but the graphical tangency
condition for optimization still holds. You can assume that this consumer still has convex
indifference curves. [3 points]

i. Let’s go back to the situation before the government’s price intervention (i.e., parts a. to c.).
A different, optimizing consumer, also with an income $500, is consuming 𝐹 = 150 and
𝐻 = 4. The government is worried that this consumer is not consuming enough housing so
decides to give him/her 2 units of housing for free. On a new graph, draw the budget
constraint before the government’s intervention. Also draw the indifference curve for the
optimal bundle. On the same graph, draw the budget constraint after the government’s
intervention. [4 points]

j. At the new optimum consumption bundle, will the consumer be better or worse off? Justify
your answer. [3 points]

k. At the new optimum consumption bundle, will the consumer buy more or less housing?
Justify your answer and be very precise on the assumptions that you are making to answer.
[4 points]

3. Let’s go back to the situation described in question 2, parts a. to c. Assume that the price of
food decreases to 𝑝# = $1. [12 TOTAL POINTS] OPTIONAL (SOLUTIONS WILL BE PROVIDED
BUT NOT GRADED)
a. Replicate your graph from question 2, a., and draw the new budget constraint. Also draw
one possible indifference curve that goes through a potentially new optimum consumption
bundle. [3 points]

b. On the same graph in part a., decompose this price change into income and substitution
effects. (Note: income and substitution effects should be denoted by changes in
consumption bundles, e.g., “from bundle A to bundle B,” not changes in budget constraints.)
[5 points]

c. Briefly explain the economic intuition behind the substitution and income effects. [4 points]
4. In class, we have learned about two special cases of indifference curves but we have not seen
their corresponding optimization problems. This question helps you understand such problems.
This question refers to Matt’s and Damon’s preferences for macaroni and cheese.

Matt likes his macaroni and cheese with exactly two ounces of macaroni for every one ounce of
cheese (he can consume partial ounces as well). He has $3 to spend. Right now, one half-pound
of macaroni, which amounts to 8 ounces, costs $1. Likewise, one half-pound of cheese, which
also has 8 ounces, also costs $1. Assume that Matt can buy either of them by the ounce (or
even partial ounces). In other words, Matt can buy any continuous partial amounts of ounces.
[29 TOTAL POINTS]

a. Given the above prices, draw Matt’s budget constraint. Carefully label anything you draw,
including labels and units. Plot macaroni (M) on the y-axis and cheese (C) on the x-axis.
Express quantities of each good as ounces. [3 points]

b. What type of preferences does Matt have? [1 point]

c. On the same graph in part a., draw Matt’s indifference curve at his optimal consumption
bundle, and label his optimal bundle (with exact units). At this optimal bundle, is the slope
of the budget constraint equal to the slope of the indifference curve? Justify your answer. [4
points]

d. Now the price of macaroni doubles. On a new graph, reproduce your graph from part a.,
and on top of that, draw Matt’s new budget constraint and his new indifference curve at
the new optimal consumption bundle. [3 points]

e. On the same graph in part d., decompose this price change into income and substitution
effects. [4 points]

Damon finds macaroni and cheese mixed together revolting, but rather likes consuming each
separately. He will consume them separately in any ratio; for him, an ounce of macaroni is just
the same as an ounce of cheese. Damon also has $2 to spend. Suppose that for him, one-half
pound (i.e., 8 ounces) of macaroni costs $1 and one-half pound (i.e., 8 ounces) of cheese costs
$2.

f. Given the above prices, draw Damon’s budget constraint. Carefully label anything you draw,
including labels and units. Plot macaroni (M) on the y-axis and cheese (C) on the x-axis.
Express quantities of each good as ounces. [3 points]

g. What type of preferences does Damon have? [1 point]

h. On the same graph in part f., draw Damon’s indifference curve at his optimal consumption
bundle, and label his optimal bundle (with exact units). At this optimal bundle, is the slope
 of the budget constraint equal to the slope of the indifference curve? Justify your answer. [3
points]

i. Now the price of macaroni quadruples. On a new graph, copy your graph from part f., and
on top of that, draw Damon’s new budget constraint and his new indifference curve at the
new optimal consumption bundle. [3 points]

j. On the same graph in part i., decompose this price change into income and substitution
effects. [4 points]

5. Jeff runs a food truck that only sells hot dogs, just outside the Department of Economics.
There are two types of consumers: (1) econ professors and (2) students. With the goal of
increasing revenue, after conversing with some Econ 100 students, he decides to offer a 10%
discount. This is what happened: [9 TOTAL POINTS] OPTIONAL (SOLUTIONS WILL BE PROVIDED
BUT NOT GRADED)

Econ Professors Students

a. Using the arc method, find the price elasticities of demand for both types of consumer. [3
points]

b. How will the revenue for each type of consumer change? Explain your answer. [3 points]

c. UC IDs for professors and students are different. In other words, Jeff can accurately
distinguish between them. So, Jeff can offer discounts to only one type of consumer if he
chooses to. If the goal is to maximize revenue, how should he structure the discount
scheme? In other words, should he offer the discount to both types, one type, or to none?
[3 points]