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Problem Set 0

Problem 1

Explain why a consumer’s optimal choice is the point at which her budget constraint is tangent to
an indifference curve.

Problem 2

Suppose U (x, y) = 4x2 + 3y 2

∂U ∂U
(a) Calculate and
∂x ∂y
(b) Evaluate these partial derivatives at x = 1, y = 2.

(c) Write the total differential for U

dy
(d) Calculate for dU = 0 - that is, what is the implied trade-off between x and y holding U
dx
constant?

(f) What is the marginal rate of substitution when x = 1, y = 2?

Problem 4

You have \$3,000 to spend on entertainment this year. The price of a day trip (T ) is \$40 and the
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price of a pizza and a movie (M ) is \$20. Suppose that your utility function is U (T, M ) = T 3 M 3 .
(a) What combination of T and M will you choose?

(b) Suppose that the price of day trips rises to \$50. How will this change your decision?

Problem 5

Assume that a person’s utility over two goods is given by

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U (x1 , x2 ) = (x1 − 5) 3 (x2 − 10) 3
The price of good x1 is equal to p1 and the price of good x2 is p2 . The total income of the
individual is given by I.

(a) Write down the budget constraint of this consumer

(b) Calculate the demand for each one of the two goods

(c) Is good x1 a normal or an inferior good? What about good x2 ? Make sure to justify your