difficult

92. Sally consumes two goods, X and Y. Her utility function is given by the expression U = 3 XY 2 . The current market price for X is $10, while the market price for Y is $5.00. Sally's current income is $500. a. b. c. d. Sketch a set of two indifference curves for Sally in her consumption of X and Y. Write the expression for Sally's budget constraint. Graph the budget constraint and determine its slope. Determine the X,Y combination which maximizes Sally's utility, given her budget constraint. Show her optimum point on a graph. (Partial quantities are possible.) (Note: MUY = 6XY and MUX = 3Y2.) Calculate the impact on Sally's optimum market basket of an increase in the price of X to 15. What would happen to her utility as a result of the price increase?

Solution: a. To draw indifference curves, pick 2 levels of utility and find the values of x and y that hold the total utility constant: Let U = 60 for Y = 2 60 = 3 x ( 2 ) 60 = 3 x 4 60 =x 12 x=5 y=3 60 = 3 x ( 3) 60 = 3 x 9
2
2

y = 2, x = 5

60 =x 27
x = 2.2 y=4 60 = 3 x ( 4 )
2

y = 3, x = 2.2

60 = 3 x 16

60 =x 48

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x = 1.25 Let U = 72 for y = 2 72 = 3 x ( 2 )

y = 4, x = 1.25

72 = 3 x 4

72 =x 12
x=6 y=3 72 = 3 x ( 3)
2

y = 2, x = 6

72 = 3 x 9

72 =x 27
x = 2.67 y=4 72 = 3 x ( 4 )
2

y=3, x=2.67

72 = 3 x 16

72 =x 48
x = 1.5 y=4, x=1.5

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b. I = Pxx + Pyy 500 = 10x + 5y

Slope =

rise 100 = = 2 run 50

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c. To maximize utility, Sally must find the point where MRS is equal to MRS = PX . PY MU X MU Y

2 recall: MU Y = 6XY, MU X = 3Y

MRS =

3Y 2 Y = 6XY 2X

PX 10 = =2 PY 5 set MRS = Y =2 2X Y = 4X Sally should consume four times as much Y as X. To determine exact quantities, substitute Y = 4X into I = PXX + PYY 500 = 10X + 5Y 500 = 10X + 5(4X) 500 = 30X X = 16.67 Y = 4(16.67) Y = 66.67 Px Py

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d. MRS remains Y PX 15 , becomes =3 2X PY 5 PX Y , = 3, Y = 6X PY 2X

Equating MRS to

Substitute Y = 6X into the equation 500 = 15X + 5Y 500 = 15X +5(6X) 500 = 45X X = 11.11 Y = 6(11.11) Y = 66.67 Before price change: U = 3(16.67)(66.67)2 = 222,289. After price change: U = 3(11.11)(66.67)2 = 148,148. Utility fell due to the price change. Sally is on a lower indifference curve. (Note: Answers may be slightly different due to rounding.)

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moderate

95. Bobby is a college student who has $500 of income to spend each semester on books and pizzas. The price of a pizza is $10 and the price of a book is $50. Diagram Bobby's budget constraint. Now, suppose Bobby's parents buy him a $300 gift certificate each semester that can only be used to buy books. Diagram Bobby's budget constraint when he has the gift certificate in addition to his $500 income. Is Bobby better-off with the gift certificates?

Solution:

Without the gift certificate, Bobby's budget constraint is indicated by the line segment from 10 books and 0 pizza to 0 books and 50 pizzas (labeled BC1). With the gift certificate that can only be used for book purchases, Bobby still cannot afford anymore than 50 pizzas. However, he is guaranteed 6 books even if he spends all his money on pizza. Since the price of books and pizza hasn't changed, the slope of his new budget constraint is the same as the slope of the old budget constraint. The new budget constraint is drawn above as BC2. Note that with the gift certificate, Bobby has an expanded opportunity set and is guaranteed more of both goods no matter what his original consumption choice on BC1 was. This implies that Bobby is strictly better-off with the gift certificate.

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moderate

99. Jane lives in a dormitory that offers soft drinks and chips for sale in vending machines. Her utility function is U = 3SC (where S is the number of soft drinks per week and C the number of bags of chips per week), so her marginal utility of S is 3C and her marginal utility of C is 3S. Soft drinks are priced at $0.50 each, chips $0.25 per bag. a. b. c. Write an expression for Jane's marginal rate of substitution between soft drinks and chips. Use the expression generated in part (a) to determine Jane's optimal mix of soft drinks and chips. If Jane has $5.00 per week to spend on chips and soft drinks, how many of each should she purchase per week?

Solution: a. MRS = MRS = MU S MU C 3C C = 3S S

b. The optimal market basket is where

MRS =

PS PC
C .5 = S .25

Requires =

C = 2, C = 2S S
Jane should buy twice as many chips as soft drinks. c. Jane must satisfy her budget constraint as well as optimal mix. Her budget constraint is: I = PSS + PCC where I = income 5.00 = .5S + .25C But she must also satisfy C = 2S, the optimal mix. Substitute 2S for C into budget constraint 5.00 = .5S + .25(2S) 5 = .5S + .5S 5=S Buy 5 soft drinks. Substitute into either expression to obtain C

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C = 2S C = 2(5) C = 10 Jane should spend her $5.00 to buy 5 soft drinks and 10 bags of chips. moderate 100. An individual consumes products X and Y and spends $25 per time period. The prices of the two goods are $3 per unit for X and $2 per unit for Y. The consumer in this case has a utility function expressed as: U(X,Y) = .5XY a. b. c. Solution: a. The budget line can be expressed as: I = PXX + PYY 25 = 3X + 2Y b. In equilibrium, maximizing utility, the following relationship must hold: MU X MU Y = PX PY In equilibrium (0.5 Y)/3 = (0.5 X)/2 2Y = 3X, Y = (3/2)X Thus the amount of Y to consume is 3/2 of the amount of X that is consumed. On the budget line 25 = 3X + 2( MUX = .5Y MUY = .5X. Express the budget equation mathematically. Determine the values of X and Y that will maximize utility in the consumption of X and Y. Determine the total utility that will be generated per unit of time for this individual.

3 X) 2

25 = 3X + 3X = 6X X = 4.17 units per time period. Y=

3 (4.17) = 6.25 units per time period. 2

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c. The total utility is U(x,y) = 0.5(4.17)(6.25) = 13.03 units of utility per time period. moderate 103. The local mall has a make-your-own sundae shop. They charge customers 35 cents for each fresh fruit topping and 25 cents for each processed topping. Barbara is going to make herself a sundae. The total utility that she receives from each quantity of topping is given by the following table: Fresh Fruit Topping # of Units Total Utility 1 2 3 4 5 6 7 8 9 10 a. b. c. d. e. Solution: 10 18 24 28 30 28 24 18 10 -6 Processed Topping # of Units Total Utility 1 2 3 4 5 6 7 8 9 10 10 20 10 0 -10 -20 -30 -40 -50 -60

What is the marginal utility of the 6th fresh fruit topping? Of the two toppings, which would Barbara purchase first? Explain. If Barbara has $1.55 to spend on her sundae, how many fresh fruit toppings and processed toppings will she purchase to maximize utility? If money is no object, how many fresh fruit toppings and processed toppings will Barbara purchase to maximize utility? Which of the basic assumptions of preferences are violated by preferences shown in the table above?

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a. The marginal utility of the 6th fresh fruit topping is -2 utils (28 utils - 30 utils). b. Barbara will purchase the topping that provides the largest marginal utility per dollar spent. The marginal utility divided by price for the first unit of fresh fruit topping is 10/.35. The marginal utility divided by price for the first unit of processed topping is 10/.25. Thus the first topping purchased will be processed (because 10/.25 > 10/.35). c. Barbara will continue to purchase toppings, one at a time, until she spends $1.55, by always selecting the topping that provides the largest marginal utility per dollar spent. Barbara will purchase 2 processed toppings first, followed by 3 fresh fruit toppings. d. If money is no object, Barbara will purchase an additional unit of each topping as long as the topping provides a positive marginal utility. In this case, 2 processed toppings and 5 fresh fruit toppings. e. The preferences used in this problem violate the assumption that consumers always prefer more of a good to less. moderate 105. John consumes two goods, X and Y. The marginal utility of X and the marginal utility of Y satisfy the following equations: MUX = Y a. b. c. Solution: a. MRS = b. Optimal mix of X and Y: MRS = Px Py MU x Y = MU y X MUY = X. The price of X is $9, and the price of Y is $12. Write an expression for John's MRS. What is the optimal mix between X and Y in John's market basket? John is currently consuming 15 X and 10 Y per time period. Is he consuming an optimal mix of X and Y?

Y 9 = =.75 X 12 John should consume 0.75 times as much Y as X

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c. John's current mix is not optimal. He should consume 0.75 times as much Y as X, rather than his current 0.67 Y for each X.

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moderate

107. The following table presents Alfred's marginal utility for each good while exhausting his income. Fill in the remaining column in the table. If the price of tuna is twice the price of peanut butter, at what consumption bundle in the table is Alfred maximizing his level of satisfaction? Which commodity bundle entails the largest level of tuna fish consumption? MU of peanut butter 0.25 0.31 0.42 0.66 Marginal Rate of Substitution

Bundle A B C D Solution: Bundle A B C D

MU of tuna 2.41 1.50 0.84 0.33

MRS =

MU pb MU t

MRS =

MU t MU pb

0.10 0.21 0.5 2

9.64 4.84 2 0.5

The optimal bundle occurs where MRS =

MU t P = t = 2. This implies that commodity MU pb Ppb

bundle C is the optimal bundle. The bundle that has the highest level of tuna fish consumption is bundle D as the marginal utility of tuna is the lowest. (Alternatively, the student could have defined MRS with the two goods reversed. In that case the optimal bundle occurs where MRS = MUpb/MUt = Ppb/Pt = . In either case, the answer is the same.)

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