Econ 349 > Answer Key for Problem Set 2

1. Indifference curves: in each of these examples, it's assumed that cowpies is measured on the vertical axis and Belhaven on the horizontal axis.
a)    vertical indifference curves with the direction of higher utility to the east.
b)    linear indifference curves with the direction of higher utility to the northeast.
c)    upward sloping (bowed away from the vertical axis) curves with the direction of higher utility to the northwest.

2. Belhaven and cowpies.
a)  5
b) 400 
c) 31.25
d) slope = -1.6 = Pb/Pc; represents the rate at which Greg must trade cowpies for belhaven
e) MRS = -1.6; represents the rate at which Greg is willing to trade cowpies for belhaven

3. Ms Phashun: If forced to buy at least C-min clothing, then her utility (U2) is lower than if she could freely allocate her income at U1.

4. Just remember to specify whether you are talking about a normal or inferior good.

5. We did this one in class.

6. Intersecting indifference curves would violate the behavioral assumptions of rationality and transitivity.

7. The key to this is to see if Nathan and Tian are able to purchase their original basket of goods before and after the price changes. If they are still able to purchase the same combination of goods after the price changes, yet are observed to actually choose a new combination, then we may infer that that are better off than in the original situation.

8. There is a difference between "willingness to buy" and "ability to buy". That’s what demand curves are all about.

9. Brian initially locates at a corner solution with U1. When his income rises to $80,000, Brian buys one car with utility U2.

10.  Bugs Bunny: Bugs initially locates at point A with utility U1. After the price of carrots increases, the budget line pivots inward and forces Bugs to relocate to point C with utility U2. The substitution effect is from A to B along the original utility curve. The income effect is from B to C (where the red line is the hypothetical budget constraint).

11. a) MRS = -3/1  (if you plot fajitas on the x-axis);  b) MRS = -6/1

12.  This is for you to ponder.

13. We did this in class.

14.  This is for you to ponder.

15. This question calls for a corner solution. You can illustrate corner solutions using the normal convex indifference curves rather than the concave curves.

16. We did this one in class.

17. Intertemporal choice. Point E (where the red lines cross) is the endowment of 1/3 k in year 1 and 2/3 k in year 2.  A positive interest rate will rotate the budget line around the endowment point E so that the line is flatter (assuming year 2 consumption is measure on the horizontal axis).

18.  Last year's budget line is in blue (and his utility was U1). This year's budget line is in red (and his utility is U2). This year's consumption of grapes must be lower than last year's. This is because grapes are more expensive this year, hence Mr. Plane has an incentive (substitution effect) to sell more of his grapes on the market rather than consume them himself.

19.  This is very similar to #16 above.

20. Mister Convex (aka Danny) should be the one buying some of both types of records. Mister Concave (aka Mike) will locate at a "corner solution" and only buy one type of music.

21. This is for you to ponder.

22. Hannah's initial choice is shown below with utility U1. When the two "free" candy bars are taken away, Hannah's choice depends on whether spinach is a normal or inferior "bad". Where do you think she'll end up under either scenario?

23. Geng Xi initially choose a 1-bedroom apartment (which leaves her with $1500 of AOG). After the subsidy, the price of apartments falls to $250 and, let's say, she chooses a 2-bedroom apartment. I've not shown the indifference curves so as to keep the graph clean. If, instead, Geng Xi is simply given the cash equivalent value of the subsidy (which is $500 for two rooms), her budget line becomes the red line. It is possible to draw a set of indifference curves such that Geng Xi would rather have the straight cash subsidy instead of the reduced price housing (in other words, she could get to a higher indifference curve on the upper segment of the red line).

24. Telephone pricing.
a) Note that the x-axis is not drawn to scale.
b) The cost of an additional 20 minutes depends on how many minutes you are currently calling.
If you are currently calling 40 minutes per month, then an extra 20 minutes would cost you $2.50. If you are currently calling 140 minutes, then an extra 20 minutes would cost you $7.50.

25.  For you to ponder.

26.  True.