ECON UN3211 - INTERMEDIATE MICROECONOMICS

Columbia University - Department of Economics

Spring 2024
Problem Set 2

1. Consider a consumer who wants to consume only two commodities and has an income of $100. Assume
the price of good 1 is $10 per unit and the price of good 2 is $20 per unit. Now, inflation causes the price
of good 1 to increase to $20 per unit, while the price of good 2 increases to $25 per unit. On the other
hand, the consumer also gets a raise of $100 (so her new income is $200). Is she better off or worse off?

2. Suppose prices are Px = 2, Py = 1 and income is m = 100.

(a) Show the change in the budget set if price of x decreased and price of y increased such that Px′ = 1
and Py′ = 2.
(b) Suppose that the government taxes (at the new set of prices Px′ = 1 and Py′ = 2) the consumer an
extra 0.50 dollar for each unit of x he buys beyond 70 units. That is, no tax is collected for units
x < 70, and 0.50 dollar tax for each x ≥ 70. Show the new budget set.
(c) Suppose that on top of part (b) government subsidizes the consumer with a 0.40 dollar for each unit
of y he buys beyond 40 units. That is, there is no subsidy for y < 40, and consumer pays 0.40 dollar
less for each y ≥ 40. Show the new budget set.

3. Consider a consumer who is choosing how many of two goods to buy: Footballs and cricket balls. The
consumer has an income of $20, and the cost of a football is $4 and a cricket ball is $2.

(a) Write down the equation for the consumer’s budget constraint and graph it.
(b) The government decides that football is evil and needs to be taxed. They introduce a 50% tax on
each football sold. Rewrite and re-graph the budget constraint.
(c) A new government is elected that hates all sports. They now tax both footballs and cricket balls at
50%. What does the budget constraint look like now?
(d) Due to a threat of revolt amongst sports fans, the government hands out a subsidy of $10 to the
consumer. What does their new budget constraint look like?
(e) Revolution comes, and all taxes and subsidies are abolished. Even better, the consumer finds a new
shop that offers bulk discounts. In this shop, footballs cost $4 each if you buy 3 or less. However,
the cost of any additional football after 3 is $2. What does the budget set look like now?

4. William has $300 to spend on food and clothing. The price of food is $2 per unit and the price of clothing
is $1 per unit.

(a) Write down the equation for William’s budget constraint and graph it.
(b) Suppose that the government gives William 100 free coupons as food stamps (assuming that William
can get free unit of food for each coupon) and strictly enforce a rule which prohibits William from
selling his food stamps to someone. Draw the new budget set.

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 (c) Suppose that the rule prohibiting the food stamps sale is difficult to enforce and William can trade
each food stamp in black market for $0.50. Draw his budget set.
(d) Suppose that in addition to 100 units of food stamps, government also gives 50 free coupons for
clothing (each coupon can be used for a free unit of clothing). Assume that trading both coupons
in black market can be prohibited. Draw the budget set.
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5. Mark has preferences for guns and banjos represented by the utility function u(xg , xb ) = xg + xb .

(a) Write down the equation for an indifference curve, that is, for some utility level ū, write down the
number of guns as a function of the number of banjos.
(b) Find the marginal rate of substitution of banjos for guns.
(c) Determine whether these preferences are convex, that is, determine whether there is diminishing
MRS property.
(d) Show that, for a budget constraint pb xb + pg xg = m, at any point of tangency between budget line
p
and indifference curves, it must be the case that xb = (1/4)( pgb )2 .
(e) What is the optimal consumption bundle, if pg = $2 , pb = $1 and m = $8?
(f) What is the optimal consumption bundle if pg = $5 , pb = $1 and m = $4?

6. Suppose that a consumer only consumes good 1 and good 2 under the following prices and income:
p1 = $2, p2 = $1 and m = $100. Consumer’s preferences can be represented by the utility function,
u(x1 , x2 ) = 3x1 + x2 .

(a) Find the optimal bundle.

(b) Now suppose that the consumer receives a coupon of $20 which can be spent only in good 2. Draw
the new budget constraint and find the new optimal consumption bundle.

7. Suppose that the preferences of a typical household for quantities of electricity (E) and gasoline (G) are
given by u(E, G) = aln(E) + (1 − a)ln(G), where 0 < a < 1. Suppose the prices of gasoline and electricity
in the units provided are both $1/unit and the household has an income of $100. Suppose in addition, the
government has chosen to ration electricity by allowing a maximum consumption of 50 units of electricity,
that is, Emax = 50.

(a) If a = 1/4, find the optimal consumption bundle of gasoline and electricity.
(b) If a = 3/4, find the optimal consumption bundle of gasoline and electricity.

8. Suppose that a consumer consumes only food (f) and entertainment (e) where pf = $5, pe = $10 and
m = $600. Suppose that the consumer has to have a minimum of 50 units of f , and a maximum of 20
units of e.

(a) Draw the budget set.

(b) Suppose the utility function is u(f, e) = f · e. Find the optimal consumption bundle.