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ECON 520: Intermediate Microeconomics

Problem Set 2
Solutions

Professor D. Weisman
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1. For Bob, we are given that MRS P  B  2

B
a) MRS P  B    2  B  2P
P
1
Let B  1 , then P  
2

Hence, Bob would give up 1 pizza for additional beer.

2
b) Let P  1 , then B  2 . Hence Bob would give up 2 beers for 1 additional pizza.

c) For Bob MRS P  B  2 ; and for Carol MRS P  B  4 .

This implies that Bob is willing to give up 2 beers for 1 additional pizza, but Carol is willing to give up 4
beers for 1 additional pizza. Because 4  2 , Carol must value pizza more than Bob. [Note: similar

reasoning implies that Bob values beer more than Carol]

2. Write down equation for the utility function and indifference map for each of the cases given
a) The MRS P  B or MRS B  P is constant. This implies the utility function is linear in Beers(B) and
Pizza(P). That is, we have a case of perfect substitutes.
(1) u  2 B  1P or more generally (1’) u   B   P , where   2
Notice that we can write (1) in the following form:
u 1
(2) B  P
2 2
1 on P implies that Carol is willing to give up 1 Beer for 1 additional Pizza, or 1
The coefficient of 
2 2
Beer for 2 additional Pizzas.
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B Indifference Map

U2

U1

U0

-1/2 -1/2 -1/2

b) This is a case of perfect complements because Bob consumes Beer and Pizza in fixed proportions:
2 Beers with every Pizza. His utility function is given by

1 
(3) u   Min  B, P   is an unknown.
2 
1
Set B  P and obtain B  2 p ; that is for every Pizza Bob consumes, he also consumes 2Beers. We
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are also told that when P  4 and B  10 , u  32 . Hence

(4) . Hence, Bob’s utility function is given by

32   Min  5, 4    4    8

1 
(5) u  8Min  B, P 
2 
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B Efficient consumption locus: Neither excess Beer

nor excess pizza

U1

U0

c) We are told that Kathy loves Pizza and is neutral toward Beer. This means that Kathy derives no
positive (or negative) utility from Beer. Also, she derives 4 units of satisfaction for each Pizza she
consumes [Note: This value of 4 is a constant.]
(6) u  4 P

B
U0 U1 U2

3. Given pP  4, pB  2 and I  100

a) Determine equilibrium number of Beers and Pizza
u 1
(1) u  2 P  4 B or B   P
4 2
Budget constraint: 2 B  4 P  100 or B  50  2 P

 1  are not
Observe that the slope of budget constraint  2  and the slope of indifference curve   
 2
equal. Hence, we will have a corner solution (i.e., allocate entirety of income to Beers or entirety of
income to Pizza). We need to determine which outcome generates higher utility.
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100
If purchase only Pizzas, P  25 and u  2  25   50 .
4
100
If purchase only Beers, B  50 and u  4  50   200 .
2
Since 200>50, purchase only Beers.
Equilibrium outcome: B 0  50; P 0  0; u 0  200 .
 1 
u  2 Min  P, B  Solve following 2 equations simultaneously:
(2)
 3 
B  3P (Efficient consumption locus) 
  3P  50  2 P  5 P  50  P  10 .
B  50  2 P (Budget constraint) 
When and .
P  10, B  30 u  2 Min  10,10  20

Hence, Equilibrium outcome: B 0  30; P 0  10; u 0  20 .

(3) .
u  4 BP  Given MU B  4 P and MU P  4 B 

Consumer equilibrium (Interior solution) requires that

MU B MU P 4P 4B
    B  2P .
pB pP 2 4
Also, the budget constraint must be satisfied. Hence, B  50  2 P . Solving these 2 equations
simultaneously yields 4 P  50 or P  12.5 and B  25 . This consumption bundle generates utility

of . Hence, the equilibrium outcome is given by:

u  4  25   12.5   1250

Equilibrium outcome: B 0  25; P 0  12.5; u 0  1250 .

b) Graphical illustration of results

(1)
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B
Equilibrium
50 (Corner Slution)

Indifference
Curve

Budget
Constrain U=200
t
25 100 P

(2)
B Indifference
Curve
50
Equilibrium

30
U=20

Budget
Constraint

10 25 P

(3)
B
Indifference
50 Curve

Equilibrium
25

U=1250
Budget
Constraint
12.5 25 P
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4. Compute marginal rates of substitution for each of the utility functions in question 3 when P  10
and B  20 .

u 1 1
(1) u  2 P  4 B and B  P  MRS P  B  ; MRS B  P  2 [These are constants]
4 2 2
 1 
(2) u  2 Min  P, B 
 3 
Efficient consumption requires B  3P . At P  10 and B  20 , we have too many Pizzas and not

enough Beers. Hence

MRS P  B  0 and MRS B  P   .
(3) u  4 BP [Recall: MU B  4 p and MU P  4 B ]
MU P 4 B B 20
MRS P  B     2
MU B 4 P P 10
1 1
MRS B  P  
MRS P  B 2

5. Utility functions from question 3 on problem set 2.

 1 
(1) u  2 P  4 B ; (2) u  2 Min  P, B  ; (3) u  4 BP
 3 
1. Utility function (1) is perfect substitutes. Three possibilities for consumer equilibrium [Normalize
pP  1 ]
 I 
 p pB  2 pP 
 0 pB  2 pP
 P

 I  pB  B  I  pP  P
Demand functions P   pB  2 pP B pB  2 pP
 pP  pB
 0 pB  2 pP  I
  pB  2 pP
  pB
(2) Perfect complements.
The efficient consumption locus is given by (i) B  3P ; The budget constraint is given by (ii)

I p
B  P  P . Solve (i) and (ii) simultaneously
pB pB

I p  p  I
3P   P  P  P 3  P    P  3 pB  pP   I
p B pB  p B  pB

I 3I
or P and B  (Demand functions)
 3 pB  p P   3 pB  p P 
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(3) “Typical preferences”

 Given MU B  4 P and MU P  4 B 

MU B MU P 4B 4P p
Equilibrium condition:     B  P P
pP pB pP p B pB
I p
Budget constraint: B  P P
pB pB
Solve simultaneously,
pP I p I I
P   P  P  P  2 pP   I  P  and B  (Demand functions)
pB pB p B 2 pP 2 pB