EXERCISES

1. Suppose that Bridget spends her income on two goods, food (F) and clothing (C).
Bridget’s preferences are represented by the utility function U (F, C)=10 FC

With food on the horizontal axis and clothing on the vertical axis, identify the level of
utility for the combination (F=10,C=5). What is the MRS of food in this combination?
Find 2-3 other combinations that achieve the same level of satisfaction? Draw a graph to
show the indifference curve and mark A, B, C etc for market baskets.

2. Suppose that Jones decided to allocate $1000 per year to an entertainment budget in the
form of hockey games or rock concerts. He likes hockey games and rock concerts both
however, he prefers to give up 2 hockey games to 1 rock concert.
A) What is Marginal Rate of Substitution of one rock concert?
B) If Hockey game costs 10 USD, Rock concert costs 20 USD. What will be the function
of the budget line? Draw a budget line, what is the slope of the function (Pricing Ratio)?
Put R (rock) on X axis, put H (hockey) on Y axis.
C) What is the optimal combination that maximizes the satisfaction?

3. The price of DVDs (D) is $20 and the price of CDs (C) is $10. Philip has a budget of
$100 to spend on the two goods.
4. a. Given the above prices and income, draw his budget line on a graph with CDs on the
horizontal axis. What is the slope?
a) If Income has changed to 200 USD, what will be the slope? draw the change in the
graph.
b) If Price of CD has increased to 20 USD, what will be the slope? Draw the change in
the graph.

5. Antonio buys five new college textbooks during his first year at school at a cost of $80
each. Used books cost only $50 each. When the bookstore announces that there will be a
10% increase in the price of new books and a 5% increase in the price of used books,
Antonio’s father offers him $40 extra.
a) What happens to Antonio’s budget line? Illustrate the change with new books on the
vertical axis and used books on the horizontal axes..
b) Is Antonio worse or better off after the price change? Explain.

6. Consumers in Georgia pay twice as much for avocados as they do for peaches. However,
avocados and peaches are the same price in California. If consumers in both states
maximize utility, what will be the marginal rate of substitution of peaches for avocados in
both states separately if price of peach is 10 USD?

7. Connie has a monthly income of $200 that she allocates among two goods: meat and
potatoes.
a. Suppose meat costs $4 per pound and potatoes $2 per pound. Let M  meat and P 
potatoes. Draw her budget constraint (put P on horizontal line, put M on vertical line)
. What is the slope of the function?
b. Suppose also that her utility function is given by the equation U(M, P)  2M  P.
What combinations of meat and potatoes should she buy to reach the utility level of
100? Draw the indifference curve and find the MRS of one unit of meat?
 8. If MRS of orange to apple is ¼. The Price of apple is given 10 USD. Find the the optimal
price of orange that maximizes the satisfaction of the consumer.

9. An individual sets aside a certain amount of his income per month to spend on his two
hobbies, collecting wine and collecting books. Given the information below, illustrate
both the price-consumption curve associated with changes in the price of wine and the
demand curve for wine.
Price Wine Price Book Quantity Wine Quantity Book Budget
$10 $10 7 8 $150
$12 $10 5 9 $150
$15 $10 4 9 $150
$20 $10 2 11 $150

11. An individual consumes two goods, clothing and food. Given the information below,
illustrate the income-consumption curve and engel curve for clothing and food.
Price Clothing Price Food Quantity Clothing Quantity Food Income
$10 $2 6 20 $100
$10 $2 8 35 $150
$10 $2 11 45 $200
$10 $2 15 50 $25

12. Suppose an investor is concerned about a business choice in which there are three
prospects—the probability and returns are given below:
Probability Return
0.4 $100
0.3 30
0.3 −30

13. Suppose that two investments have the same three payoffs, but the probability
associated with each payoff differs, as illustrated in the table below:
Payoff Probability (Investment A) Probability (Investment B)
$300 0.10 0.30
$250 0.80 0.40
$200 0.10 0.30
a. Find the expected return and standard deviation of
each investment.
b. Jill has the utility function U= 5I, where I denotes the payoff. Which investment will she
choose?

14. Consider a lottery with three possible outcomes: