De La Salle University

School of Economics

MICREC1
Term 3, AY 2018-2019

Assignment 1: Theory of Consumer Behavior– Preferences and Utility

I. Suppose you only consume two goods. You rank alternative consumption bundles (𝑥1,𝑥2)
using the function𝑈=4𝑥10.5 +2𝑥20.25 for 𝑥1 >0 and 𝑥2 >0 where 𝑥1 is the amount of good 1 that
you consume and 𝑥2 is the amount of good 2 that you consume. Use this information to answer
the following questions.

1. Find your marginal utility function for each good.

Given: U=4𝑥10.5 + 2𝑥20.25 𝑥1 > 0 and 𝑥2 > 0

Explanation: The Marginal Utility Function is the satisfaction that the consumer derives from
consuming various quantities of goods. As the quantity of good increase so as the satisfaction
of the consumer. In order to find the marginal utility function the first-order partial derivatives
will be used.

Solution: 𝑼𝟏 is the marginal utility or additional utility from additional consumption of good
1, ceteris paribus.

𝑼𝟐 is the marginal utility from additional consumption of goods 2, ceteris paribus.

𝑑𝑈(𝑥1 , 𝑥2 ) 𝟐
𝑈1 (𝑥1 , 𝑥2 ) = = (4)(0.5)𝑥10.5−1 + 0 = 2𝑥1−0.5 = 𝟎.𝟓
𝑑𝑥1 𝒙𝟏

𝑑𝑈(𝑥1 , 𝑥2 ) 𝟎. 𝟓
𝑈2 (𝑥1 , 𝑥2 ) = = 0 + (2)(0.25)𝑥20.25−1 = 0.5𝑥2−0.75 = 𝟎.𝟕𝟓
𝑑𝑥2 𝒙𝟐

2. For all feasible consumption bundles (𝑥1,2) in the domain of your utility function, do
you always prefer bundles involving more goods to less? [Hint: Results in part 1].
Explanation: Strict Monotonicity means more is better than less and based on the equation
below 𝑈1 > 0 𝑎𝑛𝑑 𝑈2 > 0 𝑖𝑛 𝑟𝑒𝑠𝑝𝑒𝑐𝑡 𝑡𝑜 𝑥1 > 0 𝑎𝑛𝑑 𝑥2 > 0 . This means that the utility is
increasing in 𝑥1 𝑎𝑛𝑑 𝑥2 . The quantity of a good increases while the quantity of the other good
is unchanged. This simply implies that the consumer will never be completely satisfied which
is called nansatiated.

2
𝑈1 (𝑥1 , 𝑥2 ) = > 0 ; 𝑥1 > 0 𝑎𝑠 𝑥1 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑠 𝑠𝑜 𝑎𝑠 𝑈1
𝑥10.5

0.5
𝑈2 (𝑥1 , 𝑥2 ) = > 0 ; 𝑥2 > 0 𝑎𝑠 𝑥2 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑠 𝑠𝑜 𝑎𝑠 𝑈2
𝑥20.75

Final Answer: With that being said, for all feasible consumption bundles (𝑥1 , 𝑥2 ) in the domain
of your utility function, the consumer will always prefer bundles involving more goods to less
because of nonsatiation.

3. Find your marginal rate of substitution between good 1 and good 2. Simplify your
answer.

Explanation: The Marginal Rate of Substitution (MRS) is defined as the rate at which a
consumer is ready to exchange a number of units good 𝑥1 for one more of good 𝑥2 at the same
level of utility.

2 0.5
Given: 𝑈1 (𝑥1 , 𝑥2 ) = 𝑈2 (𝑥1 , 𝑥2 ) =
𝑥10.5 𝑥20.75

2
𝑈1 (𝑥1 ,𝑥2 ) 0.5
𝑥1 2 𝑥20.75 2𝑥20.75 𝟒𝒙𝟎.𝟕𝟓
𝟐
Solution: 𝑀𝑅𝑆12 = = 0.5 = 𝑥 = =
𝑈2 (𝑥1 ,𝑥2 ) 𝑥10.5 0.5 0.5𝑥10.5 𝒙𝟎.𝟓
𝟏
𝑥0.75
2

4. Find the amount of good 2 for the bundle containing 75 units of good 2 and that makes
you indifferent to the consumption bundle (50, 25). Show and briefly explain the basis
for your answer.
5. Consider the two consumption bundles in part 4. Does being indifferent between these
bundles imply that your marginal rate of substitution between good 1 and good 2 are
the same for both bundles? Why or why not? What economic phenomenon does your
finding support?
 6. Consider the consumption bundles (100,80) and (102.0862,60). Demonstrate that while
you are indifferent between these two bundles, you prefer a bundle that is an average
of the two bundles. What does your result imply about your preferences? Explain.

II. Your preferences are represented by the utility function 𝑈 = 2 ln 𝑥1 + ln 𝑥2 for 𝑥1 > 0
and 𝑥2 > 0 where 𝑥1 and 𝑥2 are the quantities consumed of good 1 and good 2,
respectively. Assume that 𝑥1 is measured on the x-axis and 𝑥2 is on the y-axis. Use this
information to answer the following questions. All final answers that involve
mathematical functions must be expressed in simplified form.
1. Find your marginal utility function for each good. Based on these functions, are
you nonsatiated? Explain.

Given: U=2ln𝑥1 + ln𝑥2 for 𝑥1 > 0 and 𝑥2 > 0

Explanation: The Marginal Utility Function is the satisfaction that the consumer derives from
consuming various quantities of goods. As the quantity of good increase so as the satisfaction
of the consumer. In order to find the marginal utility function the first-order partial derivatives
will be used.

Solution: 𝑼𝟏 is the marginal utility or additional utility from additional consumption of good
1, ceteris paribus.

𝑼𝟐 is the marginal utility from additional consumption of goods 2, ceteris paribus.

𝑑𝑈(𝑥1 , 𝑥2 ) 1 𝟐
𝑈1 (𝑥1 , 𝑥2 ) = = (2) ( ) + 0 =
𝑑𝑥1 𝑥1 𝒙𝟏

𝑑𝑈(𝑥1 , 𝑥2 ) 1 𝟏
𝑈2 (𝑥1 , 𝑥2 ) = = 0+ =
𝑑𝑥2 𝑥2 𝒙𝟐

2
𝑈1 (𝑥1 , 𝑥2 ) = > 0 ; 𝑥1 > 0
𝑥1

1
𝑈2 (𝑥1 , 𝑥2 ) = > 0 ; 𝑥2 > 0
𝑥2
Final Answer: Since 𝑈1 > 0 𝑎𝑛𝑑 𝑈2 > 0 𝑖𝑛 𝑟𝑒𝑠𝑝𝑒𝑐𝑡 𝑡𝑜 𝑥1 > 0 𝑎𝑛𝑑 𝑥2 > 0 then whenever
one quantity of the bundle increase the other bundle will remain the same which means I am
nonsatiated because I would prefer more goods to less.

2. Do your preferences obey the law of diminishing marginal utility for each good?
Explain. [Hint: Use your results in part 1 and the appropriate derivatives.]

Explanation: Diminishing marginal utility means the decrease in utility as an additional unit is
consumed. To determine if my preference follows the law of diminishing marginal utility a
𝑑2𝑈
second-order partial derivative must be conducted. ( ).
𝑑𝑥12

2 1
Given: 𝑈1 = & 𝑈2 =
𝑥1 𝑥2

𝑑2𝑈 −𝟐
Solution: 𝑈11 = = (−1)(2)𝑥1−1−1 = −2𝑥1−2 = < 𝟎, 𝒙𝟏 > 𝟎 𝑴𝒂𝒙𝒊𝒎𝒖𝒎
𝑑𝑥22 𝒙𝟐𝟏

𝑑2𝑈 −1−1 −2
−𝟏
𝑈22 = = (1)(−1)𝑥2 = −1𝑥2 = < 𝟎, 𝒙𝟐 > 𝟎 𝑴𝒂𝒙𝒊𝒎𝒖𝒎
𝑑𝑥22 𝒙𝟐𝟐

Final Answer: Since 𝑈11 > 0 𝑎𝑛𝑑 𝑈22 > 0 𝑖𝑛 𝑟𝑒𝑠𝑝𝑒𝑐𝑡 𝑡𝑜 𝑥1 > 0 𝑎𝑛𝑑 𝑥2 > 0 it means that
for every good the consumer consumes their utility will decline. Thus proves that my
preferences obey the law of diminishing marginal utility.

3. Mathematically verify whether the shape of your utility function is strictly

quasiconcave or not. What does this imply about your preferences?

Explanation: For the utility function to be strictly quansiconcave, it must be that the condition
below is met

2𝑈12 𝑈1 𝑈2 − 𝑈11 𝑈22 − 𝑈22 𝑈12 > 0 ∀ 𝑥1 > 0 𝑎𝑛𝑑 𝑥2 > 0

Whenever the utility function is strictly quasi-concave then preference will be strictly convex.

2 1 −2 −1
Given:𝑈1 = 𝑈2 = 𝑈11 = 𝑈22 = 𝑈12 = 0 𝑈21 = 0
𝑥1 𝑥2 𝑥21 𝑥22
Solution: Step 1 Substitute the given values into the equation 2𝑈12 𝑈1 𝑈2 − 𝑈11 𝑈22 − 𝑈22 𝑈12

2 1 −2 1 −1 2
2(0) ( )( ) − ( 2 )( )2 − ( 2 )( )2
𝑥1 𝑥2 𝑥1 𝑥2 𝑥2 𝑥1

2 4 6
0+ + = > 0 𝑖𝑛 𝑟𝑒𝑠𝑝𝑒𝑐𝑡 𝑡𝑜 𝑥1 , 𝑥2 > 0
𝑥12 𝑥22 𝑥12 𝑥22 𝑥12 𝑥22

Final Answer: This means that the shape of the utility function is strictly quasiconcave because
it is strictly convex. This implies that I would prefer averages over extremes.

4. Find, sign and interpret using words the derivative that determines the slope of
your typical indifference curve.

𝑑𝑥2
Explanation: The slope at any point along the IC for U=𝑈1 is | 1 . If the IC is
𝑑𝑥1 𝑈=𝑈
𝑑𝑥2
downward sloping, then | 1 < 0 at any point along the IC.
𝑑𝑥1 𝑈=𝑈

−2
𝑑𝑥2 𝑈 (𝑥 ,𝑥 ) 𝑥1 −2 𝑥2 −2𝑥2
Solution: |𝑈=𝑈1 = − 1 (𝑥1 2 ) = 1 = ( )= <0 in respect to
𝑑𝑥1 𝑈2 1 ,𝑥2 𝑥1 1 𝑥1
𝑥2

𝑥1 > 0 𝑎𝑛𝑑 𝑥2 > 0

−2𝑥2
Final Answer: Since the answer resulted to < 0 in respect to 𝑥1 > 0 𝑎𝑛𝑑 𝑥2 > 0 this
𝑥1
means that the indifference curve is downward sloping or has a negative slope. The negative
slope of the IC is an implication of the assumption of non-satiation.

5. Find, sign, and interpret using words the derivative that determines the shape of
your typical indifference curve.
6. Find your marginal rate of substitution of good 1 for good 2 (𝑀𝑅𝑆12).
7. Find the derivative that determines what happens to your 𝑀𝑅𝑆12 as you
consume more of good 1 (and less of good 2) along the same indifference curve.
Based on this derivative, does your utility function obey the law of diminishing
 𝑑𝑀𝑅𝑆12
marginal rate of substitution? Why or why not? [Caution: along the same
𝑑𝑥1
𝜕𝑀𝑅𝑆12
𝐼𝐶 ≠ ]
𝜕𝑥1

8. Are your preferences homothetic? Why or why not?

%△(𝑥2 /𝑥1 )
9. Calculate and interpret your elasticity of substitution, 𝜎, where 𝜎 = =
%△𝑀𝑅𝑆12
𝑑(𝑥2 /𝑥1 ) 𝑀𝑅𝑆12 𝑑ln(𝑥2 /𝑥1 )
∙ (𝑥 = .
𝑑𝑀𝑅𝑆12 2 /𝑥1 ) 𝑑ln𝑀𝑅𝑆12

III. Your preferences are represented by the utility function for 𝑈 = 5𝑥1 + 10𝑥2 + 10𝑥1𝑥2
for 𝑥1 > 0 and 𝑥2 > 0 where 𝑥1 and 𝑥2 are the quantities consumed for good 1 and good
2, respectively. Assume that 𝑥1 is measured on the x-axis and 𝑥2 is on the y-axis. Use
this information to answer the following questions. All final answers that involve
mathematical functions must be expressed in simplified form.

1. Find your marginal utility function for each good. Based on these functions, are you
nonsatiated? Explain.
2. Does your utility function obey the law of diminishing marginal utility for each good?
Explain. [Hint: Use your results in part 1 and the appropriate derivatives.]
3. Mathematically verify whether the shape of your utility function is strictly
quasiconcave or not. What does this imply about your preferences?
4. Find your marginal rate of substitution of good 1 for good 2 (MRS12).
5. Find the derivative that determines what happens to your MRS12 as you consume more
of good 1 (and less of good 2) along the same indifference curve. Based on this
derivative, does your utility function obey the law of diminishing marginal rate of
𝑑𝑀𝑅𝑆12 𝜕𝑀𝑅𝑆12
substitution? Why or why not? [Caution: along the same 𝐼𝐶 ≠ ]
𝑑𝑥1 𝜕𝑥1

6. Are your preferences homothetic? Why or why not?

7. Suppose your best friend has the utility function 𝑉 = −10𝑥1 − 20𝑥2 − 20𝑥1𝑥2 for 𝑥1 > 0
and 𝑥2 > 0 where 𝑉 is the number assigned by the function to the consumption bundle
(𝑥1,𝑥2). Explain the concept of positive monotonic transformations, and can you say
that you and your best friend have identical preferences?

IV. For the following sets of goods, draw two indifference curves, 𝑈1 and 𝑈2 , with 𝑈2 >
𝑈1. Draw each graph placing the amount of the first good on the horizontal axis.
 1. Cookies and ice cream (the consumer likes both and has a diminishing marginal rate of
substitution of cookies for ice cream)
2. Tablets and laptops (the consumer likes both and will be willing to substitute one tablet
for one laptop to maintain a constant level of satisfaction). Additionally, give the (i)
utility function, where x1 represents the quantity of tablets and x2 represents the quantity
of laptops; (ii) the marginal rate of substitution of tablets for laptops; and (iii) the slope
of the indifference curves.
3. Peanut butter and jelly (the consumer likes exactly three spoons of peanut butter for
one spoon of jelly).

V. Suppose Michael purchases only two goods: (1) hamburgers or H and (2) Coke or C.

1. What is the relationship between 𝑀𝑅𝑆H,C and the marginal utilities 𝑀𝑈H and 𝑀𝑈C?
2. Draw a typical indifference curve for the case in which the marginal utilities of both
goods are positive and the marginal rate of substitution of hamburgers for Coke is
diminishing. Using your graph, explain the relationship between the indifference curve
and the marginal rate of substitution of hamburgers for Coke.
3. Suppose the marginal rate of substitution of hamburgers for Coke is constant. In this
case, are hamburgers and Coke perfect substitutes or perfect complements? Why?
4. Suppose that Michael always wants two hamburgers with every Coke. Draw a typical
indifference curve. In this case, are hamburgers and Coke perfect substitutions or
perfect complements? Why?