Problem Set 1 Microeconomic Theory: A Mathematical Approach (Consumers Problem1 ) 1.

You have just emerged from medical school with a debt service burden of $25,000 per year, and have set up practice. You have to decide how hard to work. For each hour of work, you expect to earn $50 (after subtracting expenses of maintaining your oce, taxes, etc.). Your utility function for a full year is U (I, H) = ln(I) + 2 ln(5000 H), where H is the number of hours you work during the year, and I is what is left of your annual income after expenses, taxes, and debt service. a) What is your budget constraint linking I and H? b) Find your optimal number of hours of work. c) If taxes go up so you are left with only $40 per hour of work, will you work more or fewer hours? Explain the economic intuition for the result. 2. There are two goods, whose quantities are denoted by X and Y , each being a real number. An individuals consumption set consists of all (X, Y ) such that X 0 and Y > 1. His utility function is: U (X, Y ) = 4 ln(X + 2) + ln(Y 1). The price of X is p and that of Y is q; total income is I. Assume q < I. Solve the consumers problem. 3. Denote a consumers daily hours of work by h, and hours of non-work by n = 24 h. Consider a consumer who has no other source of income than wages for hours worked, and no debt or other obligations. He consumes what he earns each day. Writing c for the rupees amount of his consumption, suppose his utility function is u (c, n) = ln (c) + 3 ln (n). All these quantities are to be treated as continuous variables. a) Suppose the wage rate is Rs. 10 per hour. Write down the consumers utility function and budget constraint with c and h as the choice variables. How many hours will he choose to work, and what will be the resulting utility? b) Suppose the wage rate is Rs. 10 per hour for the rst 8 hours of work each day, and Rs. 30 per hour for each daily hour of work beyond the rst 8. Write down the consumers utility function and budget constraint with c and h as the choice variables. How many hours will he choose to work, and what will be the resulting utility? 4. Consider two graduate students, Sonali and Abhishek. Each has a monthly allowance of Rs. 100, which can be spent on two things: burger, and talking to friends back home on the phone. Each burger costs Rs. 10. The phone company oers two plans. The rst has no xed fee, and charges 1 10 paise per minute of use. The second has a xed fee of Rs. 40 per month, plus 3 3 paise per minute of use. 4 Sonali has the utility function us (bs , ms ) = (bs ) ms , where bs is the number of burgers she consumes each month, and ms is her phone usage measured in units of hundred minutes. With similar notation, Abhisheks utility function is ua (ba , ma ) = ba ma . Find the optimal choice the choice of phone plan, the number of minutes spent on the phone, and the number of burgers eaten for each. 5. Consider the utility function u(x, y) = min{2x + y, x + 2y} a) Draw the indierence curve for u(x, y) = 20. Shade the area where u(x, y) 20. px b) For what values of will the unique optimum be x = 0. py px c) For what values of will the unique optimum be y = 0. py d) If neither x and y is equal to zero, and the optimum is unique, what must be the value of optimum?
1 Also solve the past year exam problems from this topic. Refer: http://economicsentrance.weebly.com/lessons.html. Contact: econschool@gmail.com

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6. Consider an individual who consumes three goods. His utility function is given by: u(x, y, z) = min{x + y, x + z}. Solve the consumers problem. 7. A mathematician named Donic consumes either gin or tonic. His preferences are rare because he thinks in the square in a way that is almost sardonic. Specically, Donic prefers larger drinks to smaller drinks but requires that the square of the amount of lime in a drink equal the sum of the squares of the amounts of gin and tonic. Find a utility function that represents Donics preferences. Find Donics demand functions for lime, gin and tonic. 8. Give a utility function to represent Tommys preferences. (Ref. 3.12(a), pg. 29 Workouts in Intermediate Micro Economics by Hal Varian.) Also plot an indierence curve representing Tommys mothers preferences, Utility= (D) = (|7 M | + |2 C|). (Ref. 3.12(b), pg. 30 Workouts in Intermediate Micro Economics by Hal Varian.) 9. Mr. A has two sons AS (Asenior) and AJ (Ajunior) with ages as and aj , respectively. Mr. A has Rs. M to divide among his sons. Mr. A derives utility from the well being of his sons in the following way: UA (UAS , UAJ ) = as log(UAS ) + aj log(UAJ ). His sons like to spend all their money on ice-creams (i) and colas (c). Utility function of AS is UAS (i, c) = max{i, c} and of AJ is UAJ (i, c) = min{i, c}, Let pi and pc be the prices of ice-cream and cola, respectively. How should Mr. A divide the money so that he maximizes his own utility? 10. Consider a consumer with utility function u(x1 , x2 ) = x1 x2 and income of Rs. 15,000 per month. Suppose that prices are p1 = 1 and p2 = 1 and that the consumer spends his entire paycheck each month. The consumers boss asks him to move to a new city that is identical to his current city except that p1 = 1 and p2 = 2. The boss oers no raise in pay. The consumer tells his boss: Asking me to move is just like if I stayed here and you cut my pay by Rs. A. I would be willing to move to the new city, but you would have to pay me Rs. B more for me to be willing to do it. Find values for A and B. 11. Sam enjoys both tea and coee equally. However, he prefers to have only one at a time (i.e. he likes to have either tea or coee and not both at a time). He likes to have a cup of tea with exactly two spoonful of sugar and a cup of coee with exactly one spoonful of sugar. One evening, he goes to a coee shop with Rs. M in his pocket and makes his order. The coee shop is owned by a stingy business man, who charges price ps for each teaspoonful of sugar bought, and pt and pc per cup for tea and coee, respectively. Give a utility function that represents Sams preferences and also the demand function for sugar, tea and coee in each of the following cases: a) If Sam prefers more cups of tea/coee to less. b) If Sam only enjoys upto one cup at a time, any additional consumption does not add to his satisfaction. 12. Suppose u(x, y, z, w) = xy + wz. Find the demand function for x. 13. A consumer of three goods has utility function u(x, y, z) = (min{x, y})a z a , with 0 < a < 1. Derive the demand functions for x, y and z. 14. Solve the consumers problem and nd the demand function for x for each of the following utility functions. Also consider a price change from p = (2, 1) to p = (1, 1) and let income be 100, decompose the total price eect into income eect and substitution eect using Hicksian Method and Slutsky Method for all the cases below. a) u(x, y) = y 2 + x b) u(x, y) = max{min{3x, 3y}, x + y} c) u(x, y) = x2 + 4y 2 + 4xy d) u(x, y) = [x + y], where [.] denotes the greatest integer function. e) u(x, y) = max{x, 2y} 2
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15. Consumer has a utility function U (x, y, z) = median{x, y, z}. Find the demand function for x. 16. Consider a consumers problem: maxx u(x1 , x2 ) p1 x1 + p2 x2 M x = (x1 , x2 ) 0. One way to rule out the potential that the non negativity constraints arent binding is to look at the marginal rate of substitution (MRS) when one of the factors gets arbitrarily close to zero. For the utility function u(x1 , x2 ), the MRS12 (x1 , x2 ) is the change in the amount of x2 required to keep the function u the same when x1 changes by a small amount. MRS12 (x1 , x2 ) is read the marginal rate of substitution of good 1 for good 2 at (x1 , x2 ) a) Consider the function u(x1 , x2 ) = x1 x2 . Starting from a point where x1 , x2 > 0, what happens to the MRS12 as x1 grows smaller and approaches zero i.e., limx1 0 MRS12 (x1 , x2 )? What happens to limx2 0 MRS21 (x1 , x2 )? b) Consider the function u(x1 , x2 ) = x1 + x2 . What is limx1 0 MRS12 (x1 , x2 )? c) Consider u(x1 , x2 ) = ln(x1 ) + x2 . What is limx1 0 MRS12 (x1 , x2 ) and limx2 0 MRS21 (x1 , x2 )? 17. Mr. A has two children, D and J. If Mr. A spends Rs. x per month on Ds education, D will score a total of x/2 points on his SAT tests. If Mr. A spends Rs. y per month on Js education, she will score a total of 2y points on her SAT tests, with the greatest relevant y will not result in 2y being more than the maximum SAT points. Mr. A has a utility function U (D, J) = min{D, J}; where D is Ds SAT score and J is Js. What can we say about his relative spending on D and Js education? 18. Consider a person who consumes two commodities x and y and has utility function u(x, y) = 1 x + y y 2 . Let good x be the numeraire and consider price vectors of the form p = (1, py ) 2 where py is the price of good y. For what price-income combinations does this consumer choose to consume positive amounts of both goods. For price-income combinations such that he consumes positive amounts of each good, write an equation for this persons Marshallian demand function for each good. 19. Tiger consumes two goods, x and y and his utility function is u(x, y) = min{ xy, x}. Draw a graph, showing a few of Tigers indierence curves. What is Tigers Marshallian demand function for each of the two goods? 20. Consider the following functions f1 (x) = max{x, 1} and f2 (x) = min{x2 , 4}. Show the following sets on a plane: a) {(x, y)|y f1 (x)} b) {(x, y)|y f2 (x)} c) {(x, y)|y = max{f1 (x), f2 (x)}}