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Q1. David's Preferences Over Books: Solution

The document contains 4 questions about deriving demand functions from utility functions and solving consumer choice problems. Question 1 derives the demand functions for books and movies from a utility function and shows they are gross substitutes. It also graphs the Engel curve for books. Question 2 derives the demand functions for lipsticks and bags from a utility function. It solves a consumer choice problem and graphs the budget constraint and Engel curve for bags. Question 3 derives the demand functions for tea and honey based on the consumer's preferences. It solves a consumer choice problem and graphs the budget line, optimal bundle, and indifference curve. Question 4 derives the demand functions for shoes and shirts from a utility function. It

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477 views

Q1. David's Preferences Over Books: Solution

The document contains 4 questions about deriving demand functions from utility functions and solving consumer choice problems. Question 1 derives the demand functions for books and movies from a utility function and shows they are gross substitutes. It also graphs the Engel curve for books. Question 2 derives the demand functions for lipsticks and bags from a utility function. It solves a consumer choice problem and graphs the budget constraint and Engel curve for bags. Question 3 derives the demand functions for tea and honey based on the consumer's preferences. It solves a consumer choice problem and graphs the budget line, optimal bundle, and indifference curve. Question 4 derives the demand functions for shoes and shirts from a utility function. It

Uploaded by

Nga Lê Nguyễn Phương
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© © All Rights Reserved
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Q1.

David’s preferences over books (𝑥1 ) and movies (𝑥2 ) are given by the following
utility function:
2 2
𝑈(𝑥1 , 𝑥2 ) = 3𝑥13 + 6𝑥23
a. Derive the demand function for books and movies as the functions of price of a book
(𝑝1 ), price of a move ticket (𝑝2 ) and income (𝑚)?
b. Are the two goods substitutes or complements?
c. Suppose that books cost one dollar each and movies cost two dollars each. Graph the
Engel curve for books. Label all intercepts and slopes with their numerical values.
Solution:
The condition to maximize utility
𝑀𝑈1 𝑝1
= (1)
𝑀𝑈2 𝑝2

and the budget constraint condition: 𝑝1 𝑥1 + 𝑝2 𝑥2 = 𝑚 (2)


1/3
𝑀𝑈1 𝑥 𝑝1
= 2 21/3 =
𝑀𝑈2 𝑥 𝑝2
1

𝑝13
⇒ 𝑥2 = 8 𝑥 (3)
𝑝23 1

Substituting (3) into (2) we have:


𝑝13
𝑝2 × 8 3 𝑥1 + 𝑝1 𝑥1 = 𝑚
𝑝2
𝑚
⇒ 𝑥1 =
𝑝13
8 2 + 𝑝1
𝑝2
𝑚
⇒ 𝑥2 =
𝑝3
8 22 + 𝑝2
𝑝1
b. The two goods are gross substitutes since if the price of movies increases the demand
of books also increases.
c. The Engel curve has a slope of 3.
𝑚

𝑥1
𝑆𝑙𝑜𝑝𝑒 = 3
Q2. Lisa’s preferences for lipsticks (𝑥1 ) and bags (𝑥2 ) are represented by the following
utility function:

2 1
𝑈(𝑥1 , 𝑥2 ) = 5𝑥13 𝑥23

a. Derive the demand function for lipsticks and bags as the functions of price of a lipstick
(𝑝1 ), price of a bag (𝑝2 ) and income (𝑚)? What is fraction of income spent on bags?
b. Suppose The price of a lipstick is 𝑝1 = $8, and the price of a bag is 𝑝2 = $5 and her
income is 𝑚 = $120. Plot the Lisa’s budget constraint. Mark all the necessary information
on the graph. Find the optimal consumption levels of lipsticks and bags.
c. Using the information in question (b), graph the Engel curve for bags. Label the
intercept and slope with their numerical values.
Solution:
The condition to maximize utility
𝑀𝑈1 𝑝1
= (1)
𝑀𝑈2 𝑝2

and the budget constraint condition: 𝑝1 𝑥1 + 𝑝2 𝑥2 = 𝑚 (2)


1 1
10 − 3 3
𝑀𝑈1 𝑥1 𝑥2 𝑝1
= 3
2 2 =
𝑀𝑈2 5 3 −3 𝑝2
𝑥1 𝑥2
3

𝑥2 𝑝1
⇒2 =
𝑥1 𝑝2
𝑝1
⇒ x2 = 𝑥
2𝑝2 1
Plugging this into the budget constraint, we can solve for 𝑥1
2𝑚
𝑥1 =
3𝑝1
𝑚
x2 =
3𝑝2
𝑚
Fraction of income spent on bags: 𝑥2 𝑝2 = ⇒ 1/3 of income is spent on bags
3

b. 𝑥1∗ = 10; 𝑥2∗ = 8

𝑥2

24

Budget line slope=-1.6

15 𝑥1

𝑆𝑙𝑜𝑝𝑒 = 15

𝑥2
Q3: Minh loves drinking tea (𝑥1 ) with honey (𝑥2 ). For each bag of tea, she would like to
add two spoons of honey.
a. Write down the utility function that represents Minh’s preferences
b. Derive her demand function for tea and honey. What is the slope of Engel curve for
honey (in terms of 𝑝1 and 𝑝2 )
c. Suppose each bag of tea costs Minh $2, a spoon of honey costs her $3 and her income is
$48, find her optimal consumption bundle. Sketch a graph with tea on the horizonal axis
and honey on the vertical axis that shows all of the following: Minh’s budget line, her
optimal bundle, the indifference curve passing through her optimal bundle. Be certain to
label the end points of the budget line and the optimal bundle with their numerical values.
Solution:
a. The utility function that represents Minh’s preferences:

𝑈(𝑥1 , 𝑥2 ) = 𝑚𝑖𝑛{2𝑥1 , 𝑥2 }

b. The condition to maximize the utility


2𝑥1 = 𝑥2
And 𝑝1 𝑥1 + 𝑝2 𝑥2 = 𝑚
⇒ 𝑝1 𝑥1 + 2𝑝2 𝑥1 = 𝑚
𝑚
⇒ 𝑥1 =
𝑝1 + 2𝑝2
2𝑚
⇒ 𝑥2 =
𝑝1 + 2𝑝2

𝑝1 +2𝑝2
The slope of the Engel curve is
2

c. 𝑥1 = 6
𝑥2 = 12
𝑥2

16

12
Budget line slope=2/3

6 24 𝑥1
Q4: Lisa’s preferences for shoes (𝑥1 ) and shirts (𝑥2 ) are represented by the following
utility function:

1
𝑈(𝑥1 , 𝑥2 ) = 7𝑥1 𝑥23
a. Derive the demand function for shoes and shirts as the functions of price of a pair of
shoes (𝑝1 ), price of a shirt (𝑝2 ) and income (𝑚)? What is fraction of income spent on
shirts?
b. Suppose The price of a pair of shoes is 𝑝1 = $4, and the price of a shirt is 𝑝2 = $5 and
her income is 𝑚 = $200. Plot the Lisa’s budget constraint. Mark all the necessary
information on the graph. Find the optimal consumption levels of shoes and shirts.
c. Using the information in question (b), graph the Engel curve for shirts. Label all
intercepts and slopes with their numerical values.
Solution
The condition to maximize utility
𝑀𝑈1 𝑝1
= (1)
𝑀𝑈2 𝑝2

and the budget constraint condition: 𝑝1 𝑥1 + 𝑝2 𝑥2 = 𝑚 (2)


1
𝑀𝑈1 7𝑥23 𝑝1
= 2 =
𝑀𝑈2 7 − 𝑝2
𝑥1 𝑥2 3
3
𝑥2 𝑝1
⇒3 =
𝑥1 𝑝2
𝑝1
⇒ x2 = 𝑥
3𝑝2 1
Plugging this into the budget constraint, we can solve for 𝑥1
3𝑚
𝑥1 =
4𝑝1
𝑚
x2 =
4𝑝2
𝑚
Fraction of income spent on bags: 𝑥2 𝑝2 = ⇒ 1/4 of income is spent on shirts
4

b. 𝑥1∗ = 37.5; 𝑥2∗ =10

𝑥2

40

Budget line slope= -4/5

50 𝑥1

𝑆𝑙𝑜𝑝𝑒 = 20

𝑥2

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