Varian Solution free essay sample

Chapter 1 NAME The Market Introduction. The problems in this chapter examine some variations on the apartment market described in the text. In most of the problems we work with the true demand curve constructed from the reservation prices of the consumers rather than the â€Å"smoothed† demand curve that we used in the text. Remember that the reservation price of a consumer is that price where he is just indi? erent between renting or not renting the apartment. At any price below the reservation price the consumer will demand one apartment, at any price above the reservation price the consumer will demand zero apartments, and exactly at the reservation price the consumer will be indi? erent between having zero or one apartment. You should also observe that when demand curves have the â€Å"staircase† shape used here, there will typically be a range of prices where supply equals demand. Thus we will ask for the the highest and lowest price in the range. We will write a custom essay sample on Varian Solution or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page 1. 1 (3) Suppose that we have 8 people who want to rent an apartment. Their reservation prices are given below. To keep the numbers small, think of these numbers as being daily rent payments. ) Person Price = A = 40 B 25 C D 30 35 E 10 F 18 G 15 H 5 (a) Plot the market demand curve in the following graph. (Hint: When the market price is equal to some consumer i’s reservation price, there will be two di? erent quantities of apartments demanded, since consumer i will be indi? erent between having or not having an apartment. ) 2 THE MARKET (Ch. 1) Price 60 50 40 30 20 10 0 1 2 3 4 5 6 7 8 Apartments (b) Suppose the supply of apartments is ? xed at 5 units. In this case there is a whole range of prices that will be equilibrium prices. What is the highest price that would make the demand for apartments equal to 5 units? $18. $15. A, B, C, D. $10 to $15. (c) What is the lowest price that would make the market demand equal to 5 units? (d) With a supply of 4 apartments, which of the people A–H end up getting apartments? (e) What if the supply of apartments increases to 6 units. What is the range of equilibrium prices? 1. 2 (3) Suppose that there are originally 5 units in the market and that 1 of them is turned into a condominium. (a) Suppose that person A decides to buy the condominium. What will be the highest price at which the demand for apartments will equal the supply of apartments? What will be the lowest price? Enter your answers in column A, in the table. Then calculate the equilibrium prices of apartments if B, C, . . . , decide to buy the condominium. NAME 3 Person High price Low price A B C D E F G H 18 15 18 15 18 15 18 15 25 18 25 15 25 18 25 18 (b) Suppose that there were two people at each reservation price and 10 apartments. What is the highest price at which demand equals supply? 18. Suppose that one of the apartments was turned into a condo- minium. Is that price still an equilibrium price? Yes. 1. 3 (2) Suppose now that a monopolist owns all the apartments and that he is trying to determine which price and quantity maximize his revenues. (a) Fill in the box with the maximum price and revenue that the monopolist can make if he rents 1, 2, . . . , 8 apartments. (Assume that he must charge one price for all apartments. ) Number Price Revenue 1 2 3 4 5 6 7 8 40 40 35 70 30 90 25 100 18 90 15 90 10 70 5 40 (b) Which of the people A–F would get apartments? A, B, C, D. $18. (c) If the monopolist were required by law to rent exactly 5 apartments, what price would he charge to maximize his revenue? d) Who would get apartments? A, B, C, D, F. (e) If this landlord could charge each individual a di? erent price, and he knew the reservation prices of all the individuals, what is the maximum revenue he could make if he rented all 5 apartments? $148. (f ) If 5 apartments were rented, which individuals would get the apartments? A, B, C, D, F. 1. 4 (2) Suppose that there are 5 a partments to be rented and that the city rent-control board sets a maximum rent of $9. Further suppose that people A, B, C, D, and E manage to get an apartment, while F, G, and H are frozen out. 4 THE MARKET Ch. 1) (a) If subletting is legal—or, at least, practiced—who will sublet to whom in equilibrium? (Assume that people who sublet can evade the city rentcontrol restrictions. ) E, who is willing to pay only F, $10 for an apartment would sublet to who is willing to pay $18. (b) What will be the maximum amount that can be charged for the sublet payment? $18. A, (c) If you have rent control with unlimited subletting allowed, which of the consumers described above will end up in the 5 apartments? B, C, D, F. (d) How does this compare to the market outcome? It’s the same. 1. (2) In the text we argued that a tax on landlords would not get passed along to the renters. What would happen if instead the tax was imposed on renters? (a) To answer this question, consider the group of people in Problem 1. 1. What is the maximum that they would be willing to pay to the landlord if they each had to pay a $5 tax on apartments to the city? Fill in the box below with these reservation prices. Person Reservation Price A B C D E F G H 35 20 25 30 5 13 10 0 (b) Using this information determine the maximum equilibrium price if there are 5 apartments to be rented. $13. c) Of course, the total price a renter pays consists of his or her rent plus the tax. This amount is $18. (d) How does this compare to what happens if the tax is levied on the landlords? It’s the same. Chapter 2 NAME Budget Constraint Introduction. These workouts are designed to build your skills in describing economic situations with graphs and algebra. Budget sets are a good place to start, because both the algebra and the graphing are very easy. Where there are just two goods, a consumer who consumes x1 units of good 1 and x2 units of good 2 is said to consume the consumption bundle, ( x1 , x2 ). Any onsumption bundle can be represented by a point on a two-dimensional graph with quantities of good 1 on the horizontal axis and quantities of good 2 on the vertical axis. If the prices are p1 for good 1 and p2 for good 2, and if the consumer has income m, then she can a? ord any consumption bundle, (x1 , x2 ), such that p1 x1 +p2 x2 ? m. On a graph, the budget line is just the line segment with equation p1 x1 + p2 x2 = m and with x1 and x2 both nonnegative. The budget line is the boundary of the budget set. All of the points that the consumer can a? ord lie on one side of the line and all of the points that the consumer cannot a? rd lie on the other. If you know prices and income, you can construct a consumer’s budget line by ? nding two commodity bundles that she can â€Å"just a? ord† and drawing the straight line that runs through both points. Example: Myrtle has 50 dollars to spend. She consumes only apples and bananas. Apples cost 2 dollars each and bananas cost 1 dollar each. You are to graph her budget line, where apples are measured on the horizontal axis and bananas on the vertical axis. Notice that if she spends all of her income on apples, she can a? ord 25 apples and no bananas. Therefore her budget line goes through the point (25, 0) on the horizontal axis. If she spends all of her income on bananas, she can a? ord 50 bananas and no apples. Therfore her budget line also passes throught the point (0, 50) on the vertical axis. Mark these two points on your graph. Then draw a straight line between them. This is Myrtle’s budget line. What if you are not told prices or income, but you know two commodity bundles that the consumer can just a? ord? Then, if there are just two commodities, you know that a unique line can be drawn through two points, so you have enough information to draw the budget line. Example: Laurel consumes only ale and bread. If she spends all of her income, she can just a? ord 20 bottles of ale and 5 loaves of bread. Another commodity bundle that she can a? ord if she spends her entire income is 10 bottles of ale and 10 loaves of bread. If the price of ale is 1 dollar per bottle, how much money does she have to spend? You could solve this problem graphically. Measure ale on the horizontal axis and bread on the vertical axis. Plot the two points, (20, 5) and (10, 10), that you know to be on the budget line. Draw the straight line between these points and extend the line to the horizontal axis. This point denotes the amount of 6 BUDGET CONSTRAINT (Ch. 2) ale Laurel can a? ord if she spends all of her money on ale. Since ale costs 1 dollar a bottle, her income in dollars is equal to the largest number of bottles she can a? ord. Alternatively, you can reason as follows. Since the bundles (20, 5) and (10, 10) cost the same, it must be that giving up 10 bottles of ale makes her able to a? ord an extra 5 loaves of bread. So bread costs twice as much as ale. The price of ale is 1 dollar, so the price of bread is 2 dollars. The bundle (20, 5) costs as much as her income. Therefore her income must be 20 ? 1 + 5 ? 2 = 30. When you have completed this workout, we hope that you will be able to do the following: †¢ Write an equation for the budget line and draw the budget set on a graph when you are given prices and income or when you are given two points on the budget line. †¢ Graph the e? ects of changes in prices and income on budget sets. †¢ Understand the concept of numeraire and know what happens to the budget set when income and all prices are multiplied by the same positive amount. †¢ Know what the budget set looks like if one or more of the prices is negative. See that the idea of a â€Å"budget set† can be applied to constrained choices where there are other constraints on what you can have, in addition to a constraint on money expenditure. NAME 7 2. 1 (0) You have an income of $40 to spend on two commodities. Commodity 1 costs $10 per unit, and commodity 2 costs $5 per unit. (a) Write down your budget equation. 101 + 52 = 40. (b) If you spent all your income on commodity 1, how much could you buy? 4. 8. Use blue ink to draw your budget line in the graph (c) If you spent all of your income on commodity 2, how much could you buy? elow. x2 8 6 4 2 ,,,,,, ,,,,,, Line Blue ,,,,,, ,,,,,, ,,,,,, Red Line ,,,,,, ,,,,,, ,,,,,,Black Shading ,,,,,, ,,,,,, ,,,,,, ,,,,,,,,,,,,, ,,,,,, ,,,,,,,,,,,,, Black Line ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, Blue ,,,,,,,,,,,,, ,,,,,,,,,,,,, Shading ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, 2 4 6 8 x1 0 (d) Suppose that the price of commodity 1 falls to $5 while everything else stays the same. Write down your new budget equation. 51 +52 = 40. On the graph above, use red ink to draw your new budget line. e) Suppose that the amount you are allowed to spend falls to $30, while the prices of both commodities remain at $5. Write down your budget equation. line. 51 + 52 = 30. Use black ink to draw this budget (f) On your diagram, u se blue ink to shade in the area representing commodity bundles that you can a? ord with the budget in Part (e) but could not a? ord to buy with the budget in Part (a). Use black ink or pencil to shade in the area representing commodity bundles that you could a? ord with the budget in Part (a) but cannot a? ord with the budget in Part (e). 2. 2 (0) On the graph below, draw a budget line for each case. BUDGET CONSTRAINT (Ch. 2) (a) p1 = 1, p2 = 1, m = 15. (Use blue ink. ) (b) p1 = 1, p2 = 2, m = 20. (Use red ink. ) (c) p1 = 0, p2 = 1, m = 10. (Use black ink. ) (d) p1 = p2 , m = 15p1 . (Use pencil or black ink. Hint: How much of good 1 could you a? ord if you spend your entire budget on good 1? ) x2 20 15 Blue Line Black Line 10 Red Line 5 0 5 10 15 20 x1 2. 3 (0) Your budget is such that if you spend your entire income, you can a? ord either 4 units of good x and 6 units of good y or 12 units of x and 2 units of y. (a) Mark these two consumption bundles and draw the budget line in th e graph below. 16 12 8 4 0 4 8 12 16 x NAME 9 (b) What is the ratio of the price of x to the price of y? 1/2. (c) If you spent all of your income on x, how much x could you buy? 16. (d) If you spent all of your income on y, how much y could you buy? 8. (e) Write a budget equation that gives you this budget line, where the price of x is 1. x + 2y = 16. 3x + 6y = 48. (f ) Write another budget equation that gives you the same budget line, but where the price of x is 3. 2. 4 (1) Murphy was consuming 100 units of X and 50 units of Y . The price of X rose from 2 to 3. The price of Y remained at 4. a) How much would Murphy’s income have to rise so that he can still exactly a? ord 100 units of X and 50 units of Y ? $100. 2. 5 (1) If Amy spent her entire allowance, she could a? ord 8 candy bars and 8 comic books a week. She could also just a? ord 10 candy bars and 4 comic books a week. The price of a candy bar is 50 cents. Draw her budget line in the box below. What is Amy’s we ekly allowance? $6. Comic books 32 24 16 8 0 8 12 16 24 32 Candy bars 10 BUDGET CONSTRAINT (Ch. 2) 2. 6 (0) In a small country near the Baltic Sea, there are only three commodities: potatoes, meatballs, and jam. Prices have been remarkably stable for the last 50 years or so. Potatoes cost 2 crowns per sack, meatballs cost 4 crowns per crock, and jam costs 6 crowns per jar. (a) Write down a budget equation for a citizen named Gunnar who has an income of 360 crowns per year. Let P stand for the number of sacks of potatoes, M for the number of crocks of meatballs, and J for the number of jars of jam consumed by Gunnar in a year. 2P + 4M + 6J = 360. (b) The citizens of this country are in general very clever people, but they are not good at multiplying by 2. This made shopping for potatoes excruciatingly di? ult for many citizens. Therefore it was decided to introduce a new unit of currency, such that potatoes would be the numeraire. A sack of potatoes costs one unit of the new currency while the same relative prices apply as in the past. In terms of the new currency, what is the price of meatballs? 2 crowns. 3 (c) In terms of the new currency, what is the price of jam? crowns. (d) What would Gu nnar’s income in the new currency have to be for him to be exactly able to a? ord the same commodity bundles that he could a? ord before the change? 180 crowns. P + 2M + 3J = (e) Write down Gunnar’s new budget equation. 80. No. Is Gunnar’s budget set any di? erent than it was before the change? 2. 7 (0) Edmund Stench consumes two commodities, namely garbage and punk rock video cassettes. He doesn’t actually eat the former but keeps it in his backyard where it is eaten by billy goats and assorted vermin. The reason that he accepts the garbage is that people pay him $2 per sack for taking it. Edmund can accept as much garbage as he wishes at that price. He has no other source of income. Video cassettes cost him $6 each. (a) If Edmund accepts zero sacks of garbage, how many video cassettes can he buy? 0. NAME 11 b) If he accepts 15 sacks of garbage, how many video cassettes can he buy? 5. 6C ? 2G = 0. (c) Write down an equation for his budget line. (d) Draw Edmund’s budget line and shade in his budget set. Garbage 20 15 10 5 ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,,Budget Line ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, Set Budget ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, ,,,,,,,,, 5 10 15 20 Video cassettes 0 2. 8 (0) If you think Edmund is odd, consider his brother Emmett. Emmett consumes speeches by politicians and university administrators. He is paid $1 per hour for listening to politicians and $2 per hour for listening to university administrators. (Emmett is in great demand to help ? ll empty chairs at public lectures because of his distinguished appearance and his ability to refrain from making rude noises. ) Emmett consumes one good for which he must pay. We have agreed not to disclose what that good is, but we can tell you that it costs $15 per unit and we shall call it Good X. In addition to what he is paid for consuming speeches, Emmett receives a pension of $50 per week. Administrator speeches 100 75 50 25 0 25 50 5 100 Politician speeches 12 BUDGET CONSTRAINT (Ch. 2) (a) Write down a budget equation stating those combinations of the three commodities, Good X, hours of speeches by politicians (P ), and hours of speeches by university administrators (A) that Emmett could a? ord to consume per week. 15X ? 1P ? 2A = 50. (b) On the graph above, draw a two-dimensional diagram showing the locus of consumptions of the two kinds of speeches that would be possible for Emmett if he consumed 10 units of Good X per week. 2. 9 (0) Jonathan Livingstone Yuppie is a prosperous lawyer. He has, in his own words, â€Å"outgrown those con? ing two-commodity limits. † Jonathan consumes three goods, unblended Scotch whiskey, designer tennis shoes, and meals in French gourmet restaurants. The price of Jonathan’s brand of whiskey is $20 per bottle, the price of designer tennis shoes is $80 per pair, and the price of gourmet restaurant meals is $50 per meal. After he has paid his taxes and alimony, Jonathan has $400 a week to spend. (a) Write down a budget equation for Jonathan, where W stands for the number of bottles of whiskey, T stands for the number of pairs of tennis shoes, and M for the number of gourmet restaurant meals that he consumes. 0W + 80T + 50M = 400. (b) Draw a three-dimensional diagram to show his budget set. Label the intersections of the budget set with each axis. M 8 5 20 T W (c ) Suppose that he determines that he will buy one pair of designer tennis shoes per week. What equation must be satis? ed by the combinations of restaurant meals and whiskey that he could a? ord? 20W +50M = 320. 2. 10 (0) Martha is preparing for exams in economics and sociology. She has time to read 40 pages of economics and 30 pages of sociology. In the same amount of time she could also read 30 pages of economics and 60 pages of sociology. NAME 13 (a) Assuming that the number of pages per hour that she can read of either subject does not depend on how she allocates her time, how many pages of sociology could she read if she decided to spend all of her time on sociology and none on economics? 150 pages. (Hint: You have two points on her budget line, so you should be able to determine the entire line. ) (b) How many pages of economics could she read if she decided to spend all of her time reading economics? 50 pages. 2. 11 (1) Harry Hype has $5,000 to spend on advertising a new kind of dehydrated sushi. Market research shows that the people most likely to buy this new product are recent recipients of M. B. A. degrees and lawyers who own hot tubs. Harry is considering advertising in two publications, a boring business magazine and a trendy consumer publication for people who wish they lived in California. Fact 1: Ads in the boring business magazine cost $500 each and ads in the consumer magazine cost $250 each. Fact 2: Each ad in the business magazine will be read by 1,000 recent M. B. A. ’s and 300 lawyers with hot tubs. Fact 3: Each ad in the consumer publication will be read by 300 recent M. B. A. ’s and 250 lawyers who own hot tubs. Fact 4: Nobody reads more than one ad, and nobody who reads one magazine reads the other. (a) If Harry spends his entire advertising budget on the business publication, his ad will be read by 10,000 recent M. B. A. ’s and by 3,000 lawyers with hot tubs. (b) If he spends his entire advertising budget on the consumer publication, his ad will be read by lawyers with hot tubs. 6,000 recent M. B. A. ’s and by 5,000 (c) Suppose he spent half of his advertising budget on each publication. His ad would be read by lawyers with hot tubs. 8,000 recent M. B. A. ’s and by 4,000 (d) Draw a â€Å"budget line† showing the combinations of number of readings by recent M. B. A. ’s and by lawyers with hot tubs that he can obtain if he spends his entire advertising budget. Does this line extend all the way to the axes? No. Sketch, shade in, and label the budget set, which includes all the combinations of MBA’s and lawyers he can reach if he spends no more than his budget. 14 BUDGET CONSTRAINT (Ch. 2) (e) Let M stand for the number of instances of an ad being read by an M. B. A. and L stand for the number of instances of an ad being read by a lawyer. This budget line is a line segment that lies on the line with equation M + 2L = 16. With a ? xed advertising budget, how many readings by M. B. A. ’s must he sacri? ce to get an additional reading by a lawyer with a hot tub? MBAs x 1000 16 2. 12 10 8 6 4 a ,,,,,,,, ,,,,,,,, ,,,,,,,, c ,,,,,,,, ,,,,,,,, ,,,,,,,, b ,,,,,,,, ,,,,,,,, Budget ,,,,,,,, ,,,,,,,, Set ,,,,,,,, ,,,,,,,, ,,,,,,,, ,,,,,,,, ,,,,,,,, ,,,,,,,, 3 5 2 4 8 Budget line 0 12 16 Lawyers x 1000 2. 12 (0) On the planet Mungo, they have two kinds of money, blue money and red money. Every commodity has two prices—a red-money price and a blue-money price. Every Mungoan has two incomes—a red income and a blue income. In order to buy an object, a Mungoan has to pay that object’s redmoney price in red money and its blue-money price in blue money. (The shops simply have two cash registers, and you have to pay at both registers to buy an object. ) It is forbidden to trade one kind of money for the other, and this prohibition is strictly enforced by Mungo’s ruthless and e? cient monetary police. †¢ There are just two consumer goods on Mungo, ambrosia and bubble gum. All Mungoans prefer more of each good to less. †¢ The blue prices are 1 bcu (bcu stands for blue currency unit) per unit of ambrosia and 1 bcu per unit of bubble gum. †¢ The red prices are 2 rcus (red currency units) per unit of ambrosia and 6 rcus per unit of bubble gum. (a) On the graph below, draw the red budget (with red ink) and the blue budget (with blue ink) for a Mungoan named Harold whose blue income is 10 and whose red income is 30. Shade in the â€Å"budget set† containing all of the commodity bundles that Harold can a? ord, given NAME 15 its? wo budget constraints. Remember, Harold has to have enough blue money and enough red money to pay both the blue-money cost and the red-money cost of a bundle of goods. Gum 20 15 10 Blue Lines 5 ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, 5 10 Red Line 15 20 Ambrosia 0 (b) Another Mungoan, Gladys, faces the same prices that Harold faces and has the same red income as Harold, but Gladys has a blue income of 20. Explain how it is that Gladys will not spend its entire blue income no matter what its tastes may be. Hint: Draw Gladys’s budget lines. ) The blue budget line lies strictly outside the red budget line, so to satisfy both budgets, one must be strictly inside the red budget line. (c) A group of radical economic reformers on Mungo believe that the currency rules are unfair. â€Å"Why should everyone have to pay two prices for everything? † they ask. They propose the following scheme. Mungo will continue to have two currencies, every good will have a blue price and a red price, and every Mungoan will have a blue income and a red income. But nobody has to pay both prices. Instead, everyone on Mungo must declare itself to be either a Blue-Money Purchaser (a â€Å"Blue†) or a RedMoney Purchaser (a â€Å"Red†) before it buys anything at all. Blues must make all of their purchases in blue money at the blue prices, spending only their blue incomes. Reds must make all of their purchases in red money, spending only their red incomes. Suppose that Harold has the same income after this reform, and that prices do not change. Before declaring which kind of purchaser it will be, We refer to all Mungoans by the gender-neutral pronoun, â€Å"it. Although Mungo has two sexes, neither of them is remotely like either of ours. ? 16 BUDGET CONSTRAINT (Ch. 2) Harold contemplates the set of commodity bundles that it could a? ord by making one declaration or the other. Let us call a commodity bundle â€Å"attainable† if Harold can a? ord it by declaring itself to be a â€Å"Blue† and buying the bundle with blue money or if Harold can a? ord the bundle by declaring itself to be a â€Å"Red† and buying it with red money. On the diagram below, shade in all of the attainable bundles. Gum 20 15 10 5 ,,,,,,,,,,,, Blue Line ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,, Line Red ,,,,,,,,,,,,, ,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,, ,,,,,,,,,,,,, ,,,,,,,,, 5 10 15 20 Ambrosia 0 2. 13 (0) Are Mungoan budgets really so fanciful? Can you think of situations on earth where people must simultaneously satisfy more than one budget constraint? Is money the only scarce resource that people use up when consuming? Consumption of many commodities takes time as well as money. People have to simultaneously satisfy a time budget and a money budget. Other examplespeople may have a calorie budget or a cholesterol budget or an alcohol-intake budget. Chapter 3 NAME Preferences Introduction. In the previous section you learned how to use graphs to show the set of commodity bundles that a consumer can a? ord. In this section, you learn to put information about the consumer’s preferences on the same kind of graph. Most of the problems ask you to draw indi? erence curves. Sometimes we give you a formula for the indi? erence curve. Then all you have to do is graph a known equation. But in some problems, we give you only â€Å"qualitative† information about the consumer’s preferences and ask you to sketch indi? erence curves that are consistent with this information. This requires a little more thought. Don’t be surprised or disappointed if you cannot immediately see the answer when you look at a problem, and don’t expect that you will ? nd the answers hiding somewhere in your textbook. The best way we know to ? nd answers is to â€Å"think and doodle. † Draw some axes on scratch paper and label them, then mark a point on your graph and ask yourself, â€Å"What other points on the graph would the consumer ? d indi? erent to this point? † If possible, draw a curve connecting such points, making sure that the shape of the line you draw re? ects the features required by the problem. This gives you one indi? erence curve. Now pick another point that is preferred to the ? rst one you drew and draw an indi? erence curve throug h it. Example: Jocasta loves to dance and hates housecleaning. She has strictly convex preferences. She prefers dancing to any other activity and never gets tired of dancing, but the more time she spends cleaning house, the less happy she is. Let us try to draw an indi? erence curve that is consistent with her preferences. There is not enough information here to tell us exactly where her indi? erence curves go, but there is enough information to determine some things about their shape. Take a piece of scratch paper and draw a pair of axes. Label the horizontal axis â€Å"Hours per day of housecleaning. † Label the vertical axis â€Å"Hours per day of dancing. † Mark a point a little ways up the vertical axis and write a 4 next to it. At this point, she spends 4 hours a day dancing and no time housecleaning. Other points that would be indi? erent to this point would have to be points where she did more dancing and more housecleaning. The pain of the extra housekeeping should just compensate for the pleasure of the extra dancing. So an indi? erence curve for Jocasta must be upward sloping. Because she loves dancing and hates housecleaning, it must be that she prefers all the points above this indi? erence curve to all of the points on or below it. If Jocasta has strictly convex preferences, then it must be that if you draw a line between any two points on the same indi? rence curve, all the points on the line (except the endpoints) are preferred to the endpoints. For this to be the case, it must be that the indi? erence curve slopes upward ever more steeply as you move to the right along it. You should convince yourself of this by making some drawings on scratch 18 PREFERENCES (Ch. 3) paper. Draw an upward-sloping curve passing through the point (0, 4) and getting steeper as one moves to the right. When you have completed this workout, we hope that you will be able to do the following: †¢ Given the formula for an indi? erence curve, draw this curve, and ? d its slope at any point on the curve. †¢ Determine whether a consumer prefers one bundle to another or is indi? erent between them, given speci? c indi? erence curves. †¢ Draw indi? erence curves for the special cases of perfect substitutes and perfect complements. †¢ Draw indi? erence curves for someone who dislikes one or both commodities. †¢ Draw indi? erence curves for someone who likes goods up to a point but who can get â€Å"too much† of one or more goods. †¢ Identify weakly preferred sets and determine whether these are convex sets and whether preferences are convex. Know what the marginal rate of substitution is and be able to determine whether an indi? erence curve exhibits â€Å"diminishing marginal rate of substitution. † †¢ Determine whether a preferenc e relation or any other relation between pairs of things is transitive, whether it is re? exive, and whether it is complete. 3. 1 (0) Charlie likes both apples and bananas. He consumes nothing else. The consumption bundle where Charlie consumes xA bushels of apples per year and xB bushels of bananas per year is written as (xA , xB ). Last year, Charlie consumed 20 bushels of apples and 5 bushels of bananas. It happens that the set of consumption bundles (xA , xB ) such that Charlie is indi? erent between (xA , xB ) and (20, 5) is the set of all bundles such that xB = 100/xA . The set of bundles (xA , xB ) such that Charlie is just indi? erent between (xA , xB ) and the bundle (10, 15) is the set of bundles such that xB = 150/xA . (a) On the graph below, plot several points that lie on the indi? erence curve that passes through the point (20, 5), and sketch this curve, using blue ink. Do the same, using red ink, for the indi? erence curve passing through the point (10, 15). b) Use pencil to shade in the set of commodity bundles that Charlie weakly prefers to the bundle (10, 15). Use blue ink to shade in the set of commodity bundles such that Charlie weakly prefers (20, 5) to these bundles. NAME 19 Bananas 40 30 20 10 ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,, ,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, Red Curve ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, Pencil Shading ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, Blue Curve ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, Blue Shading ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,,, 10 20 30 40 Apples 0 For each of the following statements about Charlie’s preferences, write â€Å"true† or â€Å"false. † (c) (30, 5) ? (10, 15). (d) (10, 15) (e) (20, 5) (f ) (24, 4) (g) (11, 14) (20, 5). (10, 10). (11, 9. 1). (2, 49). True. True. True. False. True. (h) A set is convex if for any two points in the set, the line segment between them is also in the set. Is the set of bundles that Charlie weakly prefers to (20, 5) a convex set? Yes. (i) Is the set of bundles that Charlie considers inferior to (20, 5) a convex set? No. rate of (j) The slope of Charlie’s indi? erence curve through a point, (xA , xB ), is known as his marginal substitution at that point. 20 PREFERENCES (Ch. 3) (k) Remember that Charlie’s indi? rence curve through the point (10, 10) has the equation xB = 100/xA . Those of you who know calculus will remember that the slope of a curve is just its derivative, which in this case is ? 100/x2 . (If you don’t know calculus, you will have to take our A word for this. ) Find Charlie’s marginal rate of substitution at the point, (10, 10). ?1. ?4. (l) What is his marginal rate of substitution at the point (5, 20)? (m) What is his marginal rate of substitution at the point (20, 5)? (?. 25). (n) Do the indi? erence curves you have drawn for Charlie exhibit diminishing marginal rate of substitution? Yes. 3. 2 (0) Ambrose consumes only nuts and berries. Fortunately, he likes both goods. The consumption bundle where Ambrose consumes x1 units of nuts per week and x2 units of berries per week is written as (x1 , x2 ). The set of consumption bundles (x1 , x2 ) such that Ambrose is indi? erent between (x1 , x2 ) and (1, 16) is the set of bundles such that x1 ? 0, x2 ? 0, v and x2 = 20 ? 4 x1 . The set of bundles (x1 , x2 ) such that (x1 , x2 ) ? v (36, 0) is the set of bundles such that x1 ? 0, x2 ? 0 and x2 = 24 ? 4 x1 . (a) On the graph below, plot several points that lie on the indi? erence curve that passes through the point (1, 16), and sketch this curve, using blue ink. Do the same, using red ink, for the indi? erence curve passing through the point (36, 0). b) Use pencil to shade in the set of commodity bundles that Ambrose weakly prefers to the bundle (1, 16). Use red ink to shade in the set of all commodity bundles (x1 , x2 ) such that Ambrose weakly prefers (36, 0) to these bundles. Is the set of bundles that Ambrose prefers to (1, 16) a convex set? Yes. (c) Wh at is the slope of Ambrose’s indi? erence curve at the point (9, 8)? (Hint: Recall from calculus the way to calculate the slope of a curve. If you don’t know calculus, you will have to draw your diagram carefully and estimate the slope. ) ?2/3. NAME 21 (d) What is the slope of his indi? erence curve at the point (4, 12)? ?1. Berries 40 30 20 10 ,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, Pencil Shading ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, Red Curve ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,, ,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, Red ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, Blue Curve ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, Shading ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,,,,, 10 20 30 40 Nuts , 0 (e) What is the slope of his indi? erence curve at the point (9, 12)? at the point (4, 16)? ?2/3 ?1. (f ) Do the indi? erence curves you have drawn for Ambrose exhibit diminishing marginal rate of substitution? Yes. (g) Does Ambrose have convex preferences? Yes. 3. 3 (0) Shirley Sixpack is in the habit of drinking beer each evening while watching â€Å"The Best of Bowlerama† on TV. She has a strong thumb and a big refrigerator, so she doesn’t care about the size of the cans that beer comes in, she only cares about how much beer she has. (a) On the graph below, draw some of Shirley’s indi? erence curves between 16-ounce cans and 8-ounce cans of beer. Use blue ink to draw these indi? erence curves. 22 PREFERENCES (Ch. 3) 8-ounce 8 6 Blue Lines 4 Red Lines 2 0 2 4 6 8 16-ounce (b) Lorraine Quiche likes to have a beer while she watches â€Å"Masterpiece Theatre. † She only allows herself an 8-ounce glass of beer at any one time. Since her cat doesn’t like beer and she hates stale beer, if there is more than 8 ounces in the can she pours the excess into the sink. (She has no moral scruples about wasting beer. On the graph above, use red ink to draw some of Lorraine’s indi? erence curves. 3. 4 (0) Elmo ? nds himself at a Coke machine on a hot and dusty Sunday. The Coke machine requires exact change—two quarters and a dime. No other combination of coins will make anything come out of the machine. No stores are open; no one is in sight. Elmo is so thirsty that the only thing he cares about is how many soft drinks he will be able to buy with the change in his pocket; the more he can buy, the better. While Elmo searches his pockets, your task is to draw some indi? erence curves that describe Elmo’s preferences about what he ? nds. NAME 23 Dimes 8 6 4 2 ,,,,,,,,,,,, , , ,,,,,,,,,,,, ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , Blue ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, Red , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , shading ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, shading , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, ,,,,,, ,,,,,,,,,,,, , , ,,,, ,,,,,,,,,,,,,, , ,,,,,,,,,,,, , , , ,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,, , , , ,,,,,,,,,,,,,,,,,, Black ,,,,,,,,,,,,,,,,,, ,,,,,,,,,,,, ,,,,,,,,,,,, , , ,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , lines ,,,,,,,,,,,,,,,,,, , , , ,,,,,,,,,,,,,,,,,, , , ,,,,,,,,,,,,,,,,,, , 2 4 6 8 Quarters 0 (a) If Elmo has 2 quarters and a dime in his pockets, he can buy 1 soft drink. How many soft drinks can he buy if he has 4 quarters and 2 dimes? 2. (b) Use red ink to shade in the area on the graph consisting of all combinations of quarters and dimes that Elmo thinks are just indi? rent to having 2 quarters and 1 dime. (Imagine that it is possible for Elmo to have fractions of quarters or of dimes, but, of course, they would be useless in the machine. ) Now use blue ink to shade in the area consisting of all combinations that Elmo thinks are just indi? erent to having 4 quarters and 2 dimes. Notice that Elmo has indi? erence â€Å"bands,† not indi? erence curves. (c) Does Elmo have convex preferences between dimes and quarters? Yes. (d) Does Elmo always prefer more of both kinds of money to less? No. (e) Does Elmo have a bliss point? No. (f ) If Elmo had arrived at the Coke machine on a Saturday, the drugstore across the street would have been open. This drugstore has a soda fountain that will sell you as much Coke as you want at a price of 4 cents an ounce. The salesperson will take any combination of dimes and quarters in payment. Suppose that Elmo plans to spend all of the money in his pocket on Coke at the drugstore on Saturday. On the graph above, use pencil or black ink to draw one or two of Elmo’s indi? erence curves between quarters and dimes in his pocket. (For simplicity, draw your graph 24 PREFERENCES (Ch. 3) as if Elmo’s fractional quarters and fractional dimes are accepted at the corresponding fraction of their value. ) Describe these new indi? erence curves in words. Line segments with slope ? 2. 5. 3. (0) Randy Ratpack hates studying both economics and history. The more time he spends studying either subject, the less happy he is. But Randy has strictly convex preferences. (a) Sketch an indi? erence curve for Randy where the two commodities are hours per week spent studying economics and hours per we ek spent studying history. Will the slope of an indi? erence curve be positive or negative? Negative. Steeper. (b) Do Randy’s indi? erence curves get steeper or ? atter as you move from left to right along one of them? Hours studying history 8 6 Preference direction 4 2 0 2 4 6 8 Hours studying economics 3. 6 (0) Flossy Toothsome likes to spend some time studying and some time dating. In fact her indi? rence curves between hours per week spent studying and hours per week spent dating are concentric circles around her favorite combination, which is 20 hours of studying and 15 hours of dating per week. The closer she is to her favorite combination, the happier she is. NAME 25 (a) Suppose that Flossy is currently studying 25 hours a week and dating 3 hours a week. Would she prefer to be studying 30 hours a week and dating 8 hours a week? Yes. (Hint: Remember the formula for the distance between two points in the plane? ) (b) On the axes below, draw a few of Flossy’s indi? erence curves and use your diagram to illustrate which of the two time allocations discussed above Flossy would prefer. Hours dating 40 30 Preference direction 20 (20,15) 10 (30,8) (25,3) 0 10 20 30 40 Hours studying , 3. 7 (0) Joan likes chocolate cake and ice cream, but after 10 slices of cake, she gets tired of cake, and eating more cake makes her less happy. Joan always prefers more ice cream to less. Joan’s parents require her to eat everything put on her plate. In the axes below, use blue ink to draw a set of indi? erence curves that depict her preferences between plates with di? erent amounts of cake and ice cream. Be sure to label the axes. (a) Suppose that Joan’s preferences are as before, but that her parents allow her to leave anything on her plate that she doesn’t want. On the graph below, use red ink to draw some indi? erence curves depicting her preferences between plates with di? erent amounts of cake and ice cream. Ice cream Blue curves Red curves Preference direction 10 Chocolate cake 26 PREFERENCES (Ch. 3) 3. 8 (0) Professor Goodheart always gives two midterms in his communications class. He only uses the higher of the two scores that a student gets on the midterms when he calculates the course grade. (a) Nancy Lerner wants to maximize her grade in this course. Let x1 be her score on the ? rst midterm and x2 be her score on the second midterm. Which combination of scores would Nancy prefer, x1 = 20 and x2 = 70 or x1 = 60 and x2 = 60? (20,70). b) On the graph below, use red ink to draw an indi? erence curve showing all of the combinations of scores that Nancy likes exactly as much as x1 = 20 and x2 = 70. Also use red ink to draw an indi? erence curve showing the combinations that Nancy likes exactly as much as x1 = 60 and x2 = 60. (c) Does Nanc y have convex preferences over these combinations? No. Grade on second midterm 80 60 Red curves Blue curves 40 , 20 Preference direction 0 20 40 60 80 Grade on first midterm (d) Nancy is also taking a course in economics from Professor Stern. Professor Stern gives two midterms. Instead of discarding the lower grade, Professor Stern discards the higher one. Let x1 be her score on the ? st midterm and x2 be her score on the second midterm. Which combination of scores would Nancy prefer, x1 = 20 and x2 = 70 or x1 = 60 and x2 = 50? (60,50). (e) On the graph above, use blue ink to draw an indi? erence curve showing all of the combinations of scores on her econ exams that Nancy likes exactly as well as x1 = 20 and x2 = 70. Also use blue ink to draw an indi? erence curve showing the combinations that Nancy likes exactly as well as x1 = 60 and x2 = 50. Does Nancy have convex preferences over these combinations? Yes. NAME 27 3. 9 (0) Mary Granola loves to consume two goods, grapefruits and a vocados. (a) On the graph below, the slope of an indi? rence curve through any point where she has more grapefruits than avocados is ? 2. This means that when she has more grapefruits than avocados, she is willing to give up 2 grapefruit(s) to get one avocado. (b) On the same graph, the slope of an indi? erence curve at points where she has fewer grapefruits than avocados is ? 1/2. This means that when she has fewer grapefruits than avocados, she is just willing to give up 1/2 grapefruit(s) to get one avocado. (c) On this graph, draw an indi? erence curve for Mary through bundle (10A, 10G). Draw another indi? erence curve through (20A, 20G). Grapefruits 40 30 Slope -2 20 10 Slope -1/2 45 0 10 20 30 40 Avocados (d) Does Mary have convex preferences? Yes. 3. 0 (2) Ralph Rigid likes to eat lunch at 12 noon. However, he also likes to save money so he can buy other consumption goods by attending the â€Å"early bird specials† and â€Å"late lunchers† promoted by his local d iner. Ralph has 15 dollars a day to spend on lunch and other stu?. Lunch at noon costs $5. If he delays his lunch until t hours after noon, he is able to buy his lunch for a price of $5 ? t. Similarly if he eats his lunch t hours before noon, he can buy it for a price of $5 ? t. (This is true for fractions of hours as well as integer numbers of hours. ) (a) If Ralph eats lunch at noon, how much money does he have per day to spend on other stu $10. 8 PREFERENCES (Ch. 3) (b) How much money per day would he have left for other stu? if he ate at 2 P. M.? $12. (c) On the graph below, use blue ink to draw the broken line that shows combinations of meal time and money for other stu? that Ralph can just a? ord. On this same graph, draw some indi? erence curves that would be consistent with Ralph choosing to eat his lunch at 11 A. M. Money 20 15 10 5 0 10 11 12 1 2 Time 3. 11 (0) Henry Hanover is currently consuming 20 cheeseburgers and 20 Cherry Cokes a week. A typical indi? erence curve fo r Henry is depicted below. Cherry Coke 40 30 20 10 0 10 20 30 40 Cheeseburgers NAME 29 (a) If someone o? red to trade Henry one extra cheeseburger for every Coke he gave up, would Henry want to do this? No. Yes. (b) What if it were the other way around: for every cheeseburger Henry gave up, he would get an extra Coke. Would he accept this o? er? (c) At what rate of exchange would Henry be willing to stay put at his current consumption level? 2 cheeseburgers for 1 Coke. 3. 12 (1) Tommy Twit is happiest when he has 8 cookies and 4 glasses of milk per day. Whenever he has more than his favorite amount of either food, giving him still more makes him worse o?. Whenever he has less than his favorite amount of either food, giving him more makes him better o?. His mother makes him drink 7 glasses of milk and only allows him 2 cookies per day. One day when his mother was gone, Tommy’s sadistic sister made him eat 13 cookies and only gave him 1 glass of milk, despite the fact that Tommy complained bitterly about the last 5 cookies that she made him eat and begged for more milk. Although Tommy complained later to his mother, he had to admit that he liked the diet that his sister forced on him better than what his mother demanded. (a) Use black ink to draw some indi? erence curves for Tommy that are consistent with this story. Milk 12 11 10 9 8 7 6 5 4 3 2 1 (13,1) 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 (8,4) (2,7) Cookies 30 PREFERENCES (Ch. 3) b) Tommy’s mother believes that the optimal amount for him to consume is 7 glasses of milk and 2 cookies. She measures deviations by absolute values. If Tommy consumes some other bundle, say, (c, m), she measures his departure from the optimal bundle by D = |7 ? m| + |2 ? c|. The larger D is, the worse o? she thinks Tommy is. Use blue ink in the graph above to sketch a few of Mrs. Twit’s indi? erence curves for Tommy’s consumption. (Hint: Before you try to draw Mrs. Twit’s indi? erence curves, we suggest that you take a piece of scrap paper and draw a graph of the locus of points (x1 , x2 ) such that |x1 | + |x2 | = 1. ) 3. 13 (0) Coach Steroid likes his players to be big, fast, and obedient. If player A is better than player B in two of these three characteristics, then Coach Steroid prefers A to B, but if B is better than A in two of these three characteristics, then Steroid prefers B to A. Otherwise, Steroid is indi? erent between them. Wilbur Westinghouse weighs 340 pounds, runs very slowly, and is fairly obedient. Harold Hotpoint weighs 240 pounds, runs very fast, and is very disobedient. Jerry Jacuzzi weighs 150 pounds, runs at average speed, and is extremely obedient. (a) Does Steroid prefer Westinghouse to Hotpoint or vice versa? He prefers Westinghouse to Hotpoint. (b) Does Steroid prefer Hotpoint to Jacuzzi or vice versa? He prefers Hotpoint to Jacuzzi. (c) Does Steroid prefer Westinghouse to Jacuzzi or vice versa? He prefers Jacuzzi to Westinghouse. (d) Does Coach Steroid have transitive preferences? No. e) After several losing seasons, Coach Steroid decides to change his way of judging players. According to his new preferences, Steroid prefers player A to play er B if player A is better in all three of the characteristics that Steroid values, and he prefers B to A if player B is better at all three things. He is indi? erent between A and B if they weigh the same, are equally fast, and are equally obedient. In all other cases, Coach Steroid simply says â€Å"A and B are not comparable. † (f ) Are Coach Steroid’s new preferences complete? (g) Are Coach Steroid’s new preferences transitive? No. Yes. NAME 31 (h) Are Coach Steroid’s new preferences re? exive? Yes. 3. 14 (0) The Bear family is trying to decide what to have for dinner. Baby Bear says that his ranking of the possibilities is (honey, grubs, Goldilocks). Mama Bear ranks the choices (grubs, Goldilocks, honey), while Papa Bear’s ranking is (Goldilocks, honey, grubs). They decide to take each pair of alternatives and let a majority vote determine the family rankings. (a) Papa suggests that they ? rst consider honey vs. grubs, and then the winner of that contest vs. Goldilocks. Which alternative will be chosen? Goldilocks. (b) Mama suggests instead that they consider honey vs. Goldilocks and then the winner vs. grubs. Which gets chosen? Grubs. (c) What order should Baby Bear suggest if he wants to get his favorite food for dinner? Grubs versus Goldilocks, then Honey versus the winner. d) Are the Bear family’s â€Å"collective preferences,† as determined by voting, transitive? No. 3. 15 (0) Olson likes strong co? ee, the stronger the better. But he can’t distinguish small di? erences. Over the years, Mrs. Olson has discovered th at if she changes the amount of co? ee by more than one teaspoon in her six-cup pot, Olson can tell that she did it. But he cannot distinguish di? erences smaller than one teaspoon per pot. Where A and B are two di? erent cups of co? ee, let us write A B if Olson prefers cup A to cup B. Let us write A B if Olson either prefers A to B, or can’t tell the di? erence between them. Let us write A ? B if Olson can’t tell the di? erence between cups A and B. Suppose that Olson is o? red cups A, B, and C all brewed in the Olsons’ six-cup pot. Cup A was brewed using 14 teaspoons of co? ee in the pot. Cup B was brewed using 14. 75 teaspoons of co? ee in the pot and cup C was brewed using 15. 5 teaspoons of co? ee in the pot. For each of the following expressions determine whether it is true of false. (a) A ? B. (b) B ? A. True. True. 32 PREFERENCES (Ch. 3) (c) B ? C. (d) A ? C. (e) C ? A. (f ) A B. True. False. False. True. True. True. False. True. False. False. False. Fa lse. True. , transitive? (g) B A. (h) B C. (i) A C. (j) C A. (k) A B. (l) B A. (m) B C. (n) A C. (o) C A. (p) Is Olson’s â€Å"at-least-as-good-as† relation, No. No. (q) Is Olson’s â€Å"can’t-tell-the-di? rence† relation, ? , transitive? (r) is Olson’s â€Å"better-than† relation, , transitive. Yes. Chapter 4 NAME Utility Introduction. In the previous chapter, you learned about preferences and indi? erence curves. Here we study another way of describing preferences, the utility function. A utility function that represents a person’s preferences is a function that assigns a utility number to each commodity bundle. The numbers are assigned in such a way that commodity bundle (x, y) gets a higher utility number than bundle (x , y ) if and only if the consumer prefers (x, y) to (x , y ). If a consumer has the utility function U (x1 , x2 ), then she will be indi? rent between two bundles if they are assigned the same utility. If yo u know a consumer’s utility function, then you can ?nd the indi? erence curve passing through any commodity bundle. Recall from the previous chapter that when good 1 is graphed on the horizontal axis and good 2 on the vertical axis, the slope of the indi? erence curve passing through a point (x1 , x2 ) is known as the marginal rate of substitution. An important and convenient fact is that the slope of an indi? erence curve is minus the ratio of the marginal utility of good 1 to the marginal utility of good 2. For those of you who know even a tiny bit of calculus, calculating marginal utilities is easy. To ? d the marginal utility of either good, you just take the derivative of utility with respect to the amount of that good, treating the amount of the other good as a constant. (If you don’t know any calculus at all, you can calculate an approximation to marginal utility by the method described in your textbook. Also, at the beginning of this section of the workbook, we list the marginal utility functions for commonly encountered utility functions. Even if you can’t compute these yourself, you can refer to this list when later problems require you to use marginal utilities. ) Example: Arthur’s utility function is U (x1 , x2 ) = x1 x2 . Let us ? nd the indi? rence curve for Arthur that passes through the point (3, 4). First, calculate U (3, 4) = 3 ? 4 = 12. The indi? erence curve through this point consists of all (x1 , x2 ) such that x1 x2 = 12. This last equation is equivalent to x2 = 12/x1 . Therefore to draw Arthur’s indi? erence curve through (3, 4), just draw the curve with equation x2 = 12/x1 . At the point (x1 , x2 ), the marginal utility of good 1 is x2 and the marginal utility of good 2 is x1 . Therefore Arthur’s marginal rate of substitution at the point (3, 4) is ? x2 /x1 = ? 4/3. Example: Arthur’s uncle, Basil, has the utility function U ? (x1 , x2 ) = 31 x2 ? 10. Notice that U ? (x1 , x2 ) = 3U (x1 , x2 ) ? 0, where U (x1 , x2 ) is Arthur’s utility function. Since U ? is a positive multiple of U minus a constant, it must be that any change in consumption that increases U will also increase U ? (and vice versa). Therefore we say that Basil’s utility function is a monotonic increasing transformation of Arthur’s utility function. Let 34 UTILITY (Ch. 4) us ? nd Basil’s indi? erence curve through the point (3, 4). First we ? nd that U ? (3, 4) = 3? 3? 4? 10 = 26. The indi? erence curve passing through this point consists of all (x1 , x2 ) such that 31 x2 ? 10 = 26. Simplify this last expression by adding 10 to both sides of the equation and dividing both sides by 3. You ? d x1 x2 = 12, or equivalently, x2 = 12/x1 . This is exactly the same curve as Arthur’s indi? erence curve through (3, 4). We could have known in advance that this would happen, because if two consumers’ utility functions are monotonic increasing transformations of each othe r, then these consumers must have the same preference relation between any pair of commodity bundles. When you have ? nished this workout, we hope that you will be able to do the following: †¢ Draw an indi? erence curve through a speci? ed commodity bundle when you know the utility function. †¢ Calculate marginal utilities and marginal rates of substitution when you know the utility function. Determine whether one utility function is just a â€Å"monotonic transformation† of another and know what that implies about preferences. †¢ Find utility functions that represent preferences when goods are perfect substitutes and when goods are perfect complements. †¢ Recognize utility functions for commonly studied preferences such as perfect substitutes, perfect complements, and other kinked indi? erence curves, quasilinear utility, and Cobb-Douglas utility. 4. 0 Warm Up Exercise. This is the ? rst of several â€Å"warm up exercises† that you will ? nd in Wor kouts. These are here to help you see how to do calculations that are needed in later problems. The answers to all warm up exercises are in your answer pages. If you ? d the warm up exercises easy and boring, go ahead—skip them and get on to the main problems. You can come back and look at them if you get stuck later. This exercise asks you to calculate marginal utilities and marginal rates of substitution for some common utility functions. These utility functions will reappear in several chapters, so it is a good idea to get to know them now. If you know calculus, you will ? nd this to be a breeze. Even if your calculus is shaky or nonexistent, you can handle the ? rst three utility functions just by using the de? nitions in the textbook. These three are easy because the utility functions are linear. If you do not know any calculus, ? l in the rest of the answers from the back of the workbook and keep a copy of this exercise for reference when you encounter these utility fun ctions in later problems. NAME 35 u(x1 , x2 ) 21 + 32 41 + 62 ax1 + bx2 v 2 x1 + x 2 ln x1 + x2 v(x1 ) + x2 x1 x2 xa xb 1 2 (x1 + 2)(x2 + 1) (x1 + a)(x2 + b) xa + x a 1 2 M U1 (x1 , x2 ) M U2 (x1 , x2 ) M RS(x1 , x2 ) 2 4 a v1 x1 3 6 b 1 1 1 x1 bxaxb? 1 1 2 x1 + 2 x1 + a axa? 1 2 ? ? ? ?2/3 ? 2/3 ? a/b ? v1 1 x ? 1/x1 ? v (x1 ) ? x2 /x1 2 ? ax1 bx 1/x1 v (x1 ) x2 axa? 1 xb 2 1 x2 + 1 x2 + b axa? 1 1 x2 +1 x1 +2 x2 +b x1 +a a? 1 x1 x2 36 UTILITY (Ch. 4) 4. 1 (0) Remember Charlie from Chapter 3? Charlie consumes apples and bananas. We had a look at two of his indi? erence curves. In this problem we give you enough information so you can ? nd all of Charlie’s indi? erence curves. We do this by telling you that Charlie’s utility function happens to be U (xA , xB ) = xA xB . (a) Charlie has 40 apples and 5 bananas. Charlie’s utility for the bundle (40, 5) is U (40, 5) = 200. The indi? erence curve through (40, 5) includes all commodity bundles (xA , xB ) such that xA xB = 200. So 200 the indi? erence curve through (40, 5) has the equation xB = . On xA the graph below, draw the indi? erence curve showing all of the bundles that Charlie likes exactly as well as the bundle (40, 5). Bananas 40 30 20 10 10 20 30 40 Apples (b) Donna o? ers to give Charlie 15 bananas if he will give her 25 apples. Would Charlie have a bundle that he likes better than (40, 5) if he makes this trade? Yes. What is the largest number of apples that Donna could demand from Charlie in return for 15 bananas if she expects h im to be willing to trade or at least indi? erent about trading? 30. (Hint: If Donna gives Charlie 15 bananas, he will have a total of 20 bananas. If he has 20 bananas, how many apples does he need in order to be as well-o? as he would be without trade? ) 4. 2 (0) Ambrose, whom you met in the last chapter, continues to thrive on nuts and berries. You saw two of his indi? erence curves. One indifv ference curve had the equation x2 = 20 ? 4 x1 , and another indi? erence v curve had the equation x2 = 24 ? 4 x1 , where x1 is his consumption of NAME 37 nuts and x2 is his consumption of berries. Now it can be told that Ambrose has quasilinear utility. In fact, his preferences can be represented v by the utility function U (x1 , x2 ) = 4 x1 + x2 . (a) Ambrose originally consumed 9 units of nuts and 10 units of berries. His consumption of nuts is reduced to 4 units, but he is given enough berries so that he is just as well-o? as he was before. After the change, how many units of berries does Ambrose consume? 14.