Dr. V.

Ancharaz
Microeconomic Theory: Tutorial 1

1. A consumer has a direct utility function of the form u ( x1 , x2 ) = v( x1 ) + x2 . Good

1 is a discrete good; the only possible levels of consumption of good 1 are x1 = 0
and x1 = 1. For convenience, assume that u(0) = 0 and p2 = 1.

(i) The consumer will definitely choose x1 = 1 if p1 is strictly less than what?
(ii) What is the form of the indirect utility function associated with this direct
utility function? [Hint: This is not as difficult as you think. The answer
partly follows from (i).]

2. A consumer in a 3-good economy with income m has demand functions for goods 1
and 2 given by
p p m
x1 = 100 − 5 1 + β 2 + δ
p3 p3 p3
p p m
x2 = α + β 1 + γ 2 + δ
p3 p3 p3
(i) Indicate how to calculate the demand for good 3 (but don't actually do it!).
(ii) Calculate the restrictions on the numerical values of α , β , δ , and γ
implied by utility maximization. [Hint: Check the properties of Marshallian
demand functions and the restrictions imposed by the Slutsky equation.]
(iii) Given your results in (ii), draw the consumer's indifference curve in the x1−x2
plane for a fixed level of x3.
(iv) What does your answer in (iii) imply about the form of the consumer's utility
function u(x1, x2, x3)?

3. A consumer has a utility function u ( x1 , x2 ) = max { x1 , x2 }.

(i) What is the consumer's demand function for good 1?
(ii) What is his indirect utility function?
(iii) What is his expenditure function?

[Hint: Try drawing the indifference curve. How is it different from the case of
perfect complements?]

m
4. Consider the indirect utility function given by v( p1 , p 2 , m) = .
p1 + 2 p 2

Derive the (i) demand functions, (ii) the expenditure function, and (iii) the direct
utility function.

5. Utility function u is a monotonic transformation of utility function v. Therefore, the

expenditure function e(p, u) is a monotonic transformation of the expenditure
function e(p, v ), where p is a price vector.
6. George Bush derives utility from only one good, cowboy hats. George Bush’s
compensated (Hicksian) and uncompensated (Marshallian) demand curves for
cowboy hats are identical. True or false?

7. Gina’s preferences over bananas (B) and bubble gums (G) are given by
u ( B, G ) = BG 2 . Let the prices of bananas and bubble gums be denoted PB and PG,
respectively, and assume her income is M.

(i) What is the elasticity of substitution of bubble gums for bananas?

(ii) Derive the Marshallian demands for bananas and bubble gums. How much of
her income does Gina allocate to bananas?

(iii) Derive the expenditure function.

(iv) Suppose initially PB = 2, PG = 1 and M = 100. Following the destruction of

banana plantations due to a tropical cyclone, the price of bananas doubles.
Calculate the compensating variation in Gina’s income that would allow her to
reach the original level of utility.

(v) Hence, or otherwise, calculate the magnitude of the Slutsky substitution and
income effects.

8. Brinda works for Surprises Unlimited in Port Louis. She earns Rs. 10,000 per
month, which she spends on two goods, chocolate (C) and Diet Coke (K). The
price of a chocolate bar is currently Rs. 20 while a bottle of Coke costs Rs. 10. Her
utility function is given by u (C , K ) = min{ 2C , K } .

Her employer wants to send her to work on the Island of Rodrigues, with no extra
compensation. Brinda does not mind moving to Rodrigues. Her only concern,
however, is that chocolates are twice as expensive there. She argues with her boss
that moving to Rodrigues is as bad as a cut in her pay of Rs. X. Alternatively, she
says, she would not mind moving if she got a raise of Rs. Y.

(i) Calculate X and Y.

(ii) Suppose that Brinda is constrained to move to Rodrigues with no

compensation. By how much does her demand for chocolates fall? Hence, or
otherwise, calculate the magnitude of the Hicksian substitution and income
effects.