Problem Set 3: Preference and Budget Sets.

1. 1. If the price of Y is $8 and the price of X is $4 and the marginal rate of substitution with my current market basket is -2, will my utility increase if purchase more X and less Y? Explain and draw a diagram.

1. 2. Suppose the price good x is 3 and the price of good y is 6. Total income is $120. Carefully graph the budget line, showing the intercepts and indicating the value of the slope.

1. 3. Suppose that Jones and Smith have each decided to allocate $1000 per year to an entertainment budget. They both like hockey games and rock concerts and will choose to consume positive quantities of both goods. However, they differ substantially in their preferences for these two forms of entertainment. Jones prefers hockey games to rock concerts, while Smith prefers rock concerts to hockey games.

1. a. Draw a set of indifference curves for Jones and a second set for Smith.
2. b. Using the concept of marginal rate of substitution, explain why the two sets of curves are different from each other.

1. 4. What is the consumer’s demand function for X if and X and Y are perfect complements?

1. 6. Suppose Jones and Smith have decided to allocate $1000 per year on liquid refreshment in the form of alcoholic or non-alcoholic drinks. Jones and Smith differ substantially in their preferences for these two forms of refreshment. Jones prefers alcoholic to non-alcoholic drinks while Smith prefers the non-alcoholic option.

1. a. Draw indifference curves for Jones and a second set for Smith.

1. b. Discuss why the two sets of curves are different from each other using the concept of Marginal Rate of Substitution.

1. c. If both Smith and Jones pay the same prices for their refreshments, will their marginal rates of substitution of alcoholic for non-alcoholic drinks be the same or different. Explain

1. 7. Fred purchases 100 loaves of bread per year when the price is $1 per loaf. The price increases to $1.50. To offset the harm to Fred, his father gives him $50 per year. Will Fred be better off or worse off after the price increase plus the gift than he was before? Will his consumption of bread increase or decrease?

1. 8. A consumer is willing to trade one pound of chicken for three pounds of pork. He is currently purchasing as much chicken as pork per month. The price of chicken is twice the price of pork. Should he increase his consumption of pork and reduce his consumption of chicken? Or should he reduce his consumption of pork and increase his consumption of chicken? Explain and draw a picture.

1. 9. Darrell has a monthly income of $60. He spends this money making telephone calls to his home (measured in minutes of calls) (c) and on other goods (y). His mobile phone company offers him two plans:

Plan A: Pay no monthly fee and make calls for $0.50 per minute

Plan B: Pay a $20 monthly fee and makes calls for $0.20 per minute

Graph Darrell’s budget constraint under each of the two plans. If Plan A is better for him, what is the set of baskets he may purchase if his behavior consistent with utility maximization (that is, picking the best choices given standard preferences). What baskets might he purchase if plan B is better for him?

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Solution: The downloadable solution consists of 11 pages, 1114 words and 12 charts.
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