PROBLEM SET 6

1. For this problem, assume that Joe has $80 to spend on books and movies
each month, and that both goods must be purchased whole (not fractional
units). ovies cost $8 each, while books cost $!0 each. Joe"s preferences for
movies and books are summari#ed b$ the following information%
MOVIES BOOKS
No.
per
month
TU MU MU/$ No. per
month
TU MU MU/$
& '0 (((( (((( & !! (((( ((((
! 80 (((( (((( ! )! (((( ((((
* &00 (((( (((( * '! (((( ((((
) &&0 (((( (((( ) '+ (((( ((((
' &&, (((( (((( ' ,0 (((( ((((
, &!& (((( (((( , ,! (((( ((((
+ &!* (((( (((( + ,* (((( ((((
a. Fill in the figures for marginal utilit$ and marginal utilit$ per dollar for both
movies and books.
b. -re these preferences consistent with the .law of diminising marginal utilit$/0
12plain briefl$.
c. 3iven the butget of $80, what 4uantit$ of books and what 4uantit$ of movies
ma2imi#e Joe"s level of satisfaction0 12plain briefl$.
. 5raw the budget constraint (with books on the hori#ontal a2is) and identif$ the
optimal conditions of books and movies as point -.
e. 6ow suppose that price of books falls to &0$. 7hich of the colums in the table
must be recalculated0 5o the re4uired recalculations.
!. -fter the price change, how man$ movies and books will Joe purchase0
". 5raw in the new budget constraint and identif$ the new optimal combination of
books and movies as point 8.
h. 9f $ou calculated correctl$, $ou have found that a decrease in the price of
books has caused this person to bu$ more movies as well as more books.
:ow can this be0
#. -ssume that Jim is a rational consumer who consumes onl$ two goods,
apples (-) and nuts (6). -ssume that his marginal rate of substitution of
apples for nuts is given b$ the following formula%
MRS = MU
N
/ MU
A
= A / N
;hat is, Jim"s <= is simpl$ e4ual to the ratio of the number of apples consumed
to the number of nuts consumed.
a. -ssume that Jim"s income is $&00, the price of nuts is $', and price of apples
is $&0. 7hat 4uantities of apples and nuts will be consumed0
b. Find two additional points on his demand curve for nuts (>
6
? $&0 and >
6
?
$!).
c. =ketch one of the e4uilibrium points on an indifference curve graph.
$. @onsider a person who spends a total of $!00 on hats and violets. ;he price
of hats is $!0, and the price of violets is $'. 5raw a budget line with hats on
the hori#ontal a2is and violets on the vertical a2is.
a. 7hat is the slope of the bugdet line0
b. 5raw a convential indifference curve (negativel$ sloped and conve2 to the
origin) that intersects the budget line. 12plain wh$ the consumer can reach a
higher utilit$ level than that shown b$ this indifference curve.
c. 5raw a second indifference curve that shows a higher possible utilit$ level.
. @omplete the statement% ;o ma2imi#e utilit$, the consumer finds the
combination of hats and violets such that (((((((((((((( e4uals ).
%. &'"(re 1 ) Ut'*'t+ o! ,on-(m'n" .rape- an Banana-
>ounds of
3rapes
' !, *) *8 )0 )&
) !' ** *+ *A )0
* !* *& *' *+ *8
! !0 !8 *! *) *'
& &, !) !8 *0 *&
& ! * ) '
>ounds of 8ananas
Bsing the Figure & above, find the 4uantit$ of each good the consumer will
purchase in the following cases
,a-e B("et Pr'ce o! .rape Pr'ce o!
Banana-
- $+ $& $&
8 $, $! $&
@ $8 $& $!
M(*t'p*e ,ho'ce /(e-t'on-
1) <efer to the graph below. 7hat is the marginal rate of substitution0
a0 ;he indifference curve.
b0 ;he slope of the budget line.
c0 ;he budget line.
0 ;he ratio of the prices of goods C and D.
e0 ;he slope of the indifference curve.
2) Fill in the blanks.

8oth the income and substitution effects impl$ a (((((((((( relationship
between price and 4uantit$ demanded. ;he substitution effect is the change in
4uantit$ demanded attributable to a change in (((((((((( price, while the
income effect is the change attributable to a change in (((((((((( price.
a0 positive, relative, absolute.
b0 negative, relative, absolute.
c0 positive, absolute, relative.
0 negative, absolute, relative.
3) =uppose $ou have a fi2ed budget for two goods, C and D. >2 ? $&0 and >$ ? $'.
B2? ,0 utils and B$ ? &' utils. =hould the consumption of C andEor D be
higher, lower, or remain the same0
a0 @onsumption of good X should decrease, and consumption of good Y should
increase.
b0 8oth the consumption of goods X and Y should decrease.
c0 8oth the consumption of goods X and Y should increase.
0 @onsumption of good X should increase, and consumption of good Y should
decrease.
e0 ;he current combination of goods ma2imi#es total utilit$. @onsumption should
remain the same.
4) <efer to the graph below. 7hat happens when the consumer bu$s * units of good
C and ) units of good D0
a0 Btilit$ could increase b$ bu$ing more of good C and less of good D.
b0 Btilit$ could increase b$ bu$ing more of good D and less of good C.
c0 ;he utilit$ ma2imi#ingFrule holds, and the combination of goods chosen is the
optimal combination.
0 Btilit$ is ma2imi#ed although the consumer ma$ not have e2hausted her entire
income.
e0 ;he consumerGs income has been e2hausted, but the utilit$Fma2imi#ing rule
ma$ or ma$ not be satisfied.
5) 9n the formula below, the marginal utilit$ per dollar spent on good C is less than
the marginal utilit$ per dollar spent on good D. ;o increase total utilit$, the
consumer should%
a0 5ecrease the consumption of both goods.
b0 9ncrease the consumption of both goods.
c0 9ncrease the consumption of good D.
0 9ncrease the consumption of good C.
e0 aintain consumption constant.
6) ;o determine the utilit$Fma2imi#ing combination of goods C and D the consumer
will purchase, the following assumption(s) are made%
a0 ;he price of good C remains constant.
b0 ;he price of good D remains constant.
c0 ;he consumerGs income remains constant.
0 -ll of the above.
7) 7hen diminishing returns are present in consumption, the relationship between
total utilit$ and marginal utilit$ is as follows%
a0 ;otal utilit$ increases at an increasing rate while marginal utilit$ decreases.
b0 ;otal utilit$ and marginal utilit$ decrease at an increasing rate.
c0 ;otal utilit$ increases at a decreasing rate while marginal utilit$ decreases.
0 ;otal utilit$ decreases at an increasing rate while marginal utilit$ decreases.
8) <efer to the graphs below. 7hat e2plains the moves in the budget lines, - and 8,
respectivel$0
a0 8oth the rotation in - and the shift in 8 are caused b$ decreases in income.
b0 8oth the rotation in - and the shift in 8 are caused b$ increases in the prices of
goods C and D.
c0 8oth the rotation in - and the shift in 8 are caused b$ increases in income.
0 8oth the rotation in - and the shift in 8 are caused b$ decreases in the prices of
goods C and D.
e0 6one of the above.