Universidad Carlos III Microeconomics

ANSWER KEY TO PROPOSED CONSUMER THEORY

EXERCISES

1. a) Monotonicity. b) Completeness. c) Monotonicity. d) Transitivity.

2. a) Positive slope. b) The indi¤erence curve for B is ‡atter.
3. MRS becomes more vertical when we increase the consumption of movies; concave
curves.
4. Goods are substitutes; indi¤erence curves are straight lines.
5. Goods are complements; indi¤erence curves are L-shaped.
7. a) y = 81=x. b) y = 81=x: c) y = 81=x. d) y = 81=x. e) M RS(x; y) = y=x
for all the cases.
8. a) Yes. b) No; c) No; no; yes.
9. We draw a budget set according to the following equations: let pG = 0:05 e=m3 ;
pE = 0:06 e/(Kw/h); p0E = 0:03 e/(Kw/h); if E 1000; pE E + pG G = 120; if
E > 1000; pE 1000 + p0E (E 1000) + pG G = 120:
10. a) Let I be the individual’s income, c the cost of the pass, p the price of the
trip under ordinary tari¤, and p0 < p the price of the trip with the pass . Let us
normalize the price of the "other goods" to 1: Let us denote by V the number of
trips consumed and by O the consumption of "other goods". If consumer does not
purchase the pass, his budget constraint will be pV + O = I; if consumer purchases
the pass, p0 V + O = I c: b) False. The expenditure can be greater or equal.
11. a) Hint: the budget line crosses the Y -axis at I T if we normalize the price of
"other goods" to 1. The …rst part of the budget line, up till x1 is horizontal. b) It
depends on preferences, but it is not likely because water has no perfect substitutes.
c) It depends on preferences and on the level of x1 , but for x1 small enough we could
expect a negative answer. d) Yes.
13. He should increase the consumption of x and decrease theconsumption of y, if it
is possible given the income.
14. a) (x ; y ) = (100=9; 200=9): b) x(px ; py ; I) = 3pI x ; y(px ; py ; I) = 3p
2I
y
: c) For
I I 2I 2I
(px ; py ) = (3; 3); x (I) = 3px = 9 ; y (I) = 3py = 9 ; for (px ; py ) = (1; 2); xE (I) =
E E

I
3px
= I3 , y E (I) = 3p
2I
y
= I3 ; both x and y are normal goods. d) For (I; py ) =
(100; 3); xd (px ) = 3pI x = 100
3px
; for (I; py ) = (500; 3); xd (px ) = I
3px
= 500
3px
; x and y are
independent goods.
15. a) (x ; y ) = (20; 30): b) x(px ; py ; I) = 10 ppxy if I > 10py ; x(px ; py ; I) = pIx if
I 10py ; y(px ; py ; I) = pIy 10 if I > 10py ; y(px ; py ; I) = 0 if I 10py .c) SE = T E =
10; IE = 0; x is an ordinary good independent of the income; y is independent of x
(@y d =@px = 0), x is substitute for y (@xd =@py > 0). Both goods describe quasilinear
preferences.

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16. a) (x ; y ) = (15; 0); (x 0 ; y 0 ) = (0; 15); any (x 00 ; y 00 ) such that 2x + y = 15 (bud-
get constraint for prices (p00x ; p00y ) = (2; 1)). b) (x(px ; py ; I); y(px ; py ; I)) = (I=px ; 0) if
h y(pxi; py ; I)) = (0; I=py ) if px > 2py ; (x(px ; py ; I); y(px ; py ; I)) =
px < 2py ; (x(px ; py ; I);
( ;I py
px
); with 2 0; pIx if px = 2py :
17. a) Indiference curves: L-shaped with vertices on the straight line y = x; budget
constraint: 4x + 2y = 200; optimal bundle: (x ; y ) = (100=3; 100=3): b) Budget
constraint: 4x + 2y = 200 if x 10; 10 4 + 5(x 10) + 2y = 200 if x > 10; optimal
bundle: (x ; y ) = (30; 30):
18. a) t(4) = 0: b) t(9) = 8; t(11:25) = 10: c) w 5: d) SE = 2:4656; IE = 0:4656
23. a) x(px = 1; py = 1; ra = 250; rb = 100) = 175; y(px = 1; py = 1; ra = 250; rb =
100) = 175; x(px = 1; py = 1; ra = 200; rb = 150) = 175; y(px = 1; py = 1; ra =
200; rb = 150) = 175: b) x(px = 1; py = 1; ra = 250; rb = 100) = 175:29; y(px =
1; py = 1; ra = 250; rb = 100) = 174:71; x(px = 1; py = 1; ra = 200; rb = 150) =
175:43; y(px = 1; py = 1; ra = 200; rb = 150) = 174:57:
24. a) (x ; y ) = (3:75; 2:5): b) y(px ; py ; I) = 2pI y ; "p (y) = 1: c) SE = 0:688; IE =
0:562: d) Normal; no. e) For (px ; py ) = (2; 3); xE (I) = I4 ; for (px ; py ) = (3; 3); xE (I) =
I
9
.
25. SE = 0; IE = T E = 1:
28. a) t(20) = 24; h(20) = 0: b) t(w) = 14 + w2 , if w 20; t(w) = 24 if w > 20;
w2
c(w) = 2 14w if w 20; c(w) = 24w if w > 20. c) SE = T E = 2; IE = 0:
33. a) (h ; t ) = (24; 2); e = 4: b) Less. c) SE = 7:03; IE = 4:03:
34. a) Before: (c ; h ) = (2=9; 22); after: (c ; h ) = (1=3; 24): b) (c ; h ) = (1=3; 24):
c) Individual chooses the same optimal point, and therefore gets the same utility in
both systems (so, he is indi¤erent between the two options); as the individual do not
work independently of the system, government has to pay the same amount of money
for shcolarships in both cases (is also indi¤erent).
38. a) t(w; M ) = 1 M w
0: b) LS (w) = 5 if w < 3; LS (w) = 10 15
w
if w 3;
(w ; L ) = (3:5; 40=7); worker surplus = 17:678:
40. Give the subsidy, because the cost for the government is less than the consumer’s
valuation (CV < EV )
43. a) I1 = 420:733; CV = 170:733: b) CP Iverd = 1:683; CP ILasp = 1; 7:
44. a) CP Ieco = 0:13: b) Consumer 1, because su¤ers a higher in‡ation than the
in‡ation due to his purchasing decisions.
45. a) (x ; y ) = (1250; 100): b) (x 0 ; y 0 ) = (1000; 66:67): c) I = 4924:848:
47. a) h(4) = 4: b) h(8=3) = 4; SE = 1:4216; IE = 1:4216: c) h(4) = 3: d) He
prefers the taxation system of part (c):
48. a) (x ; y ) = (I=2; I): b) S = 0:41I: c) S 0 = 0:5I; S 0 S; the …rst option is more
expensive.

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50. a) He is indi¤erent; yes, he will invest; no, he will not invest. b) No; yes. c) Yes;
if b > 1=4, he will invest; if b < 1=4, he will not invest; if b = 1=4, he is indi¤erent.
52. a) He should produce the movie. b) No.
53. Betting once is the optimal decision.
55. Do not do the drilling; do not do the drilling.
59. a) Yes; no. b) CE = 37; RP = 64:
60. a) x = 266:67e. b) Good drivers will not purchase the insurance; bad drivers
will.
62. a) The optimal choice is the third one. b) The value of perfect information is
2400e.
63. a) He will buy the apartment. b) Yes.
64. a) 248000 e. b) 18000 e
65. 6 million euros; zero.
66. a) Declaring nothing at all. b) For m 47500e. c) No, in both cases he prefers
to declare nothing.
p d) Yes; we p can get the value of that information by solving
900 = 0:1(2 125000 k) + 0:9(2 250000 k); from which we obtain k = 32:629: