Economics 3070

Fall 2014

Problem Set 2 Solutions

1. Graph a typical indifference curve for the following utility functions and
determine whether they obey the assumption of diminishing MRS:
a. U(x, y) = 3x + y
y
3
Slope = -3

U =3
1

Since the indifference curves are not bowed towards the origin, they do not obey the
assumption of diminishing MRS.
b. U(x, y) =

xy
y

4
2
1

U =2
1

Since the indifference curves are bowed towards the origin, they do obey the
assumption of diminishing MRS. Alternatively, we know MUx and MUy are both
positive. So when quantity of X increases, quantity of Y must decrease. The
MRSxy = Y/X . So as X increase, the denominator gets bigger and MRS decreases.
As X increase, Y decreases and the numerator gets smaller so MRS decreases. Both
these effects work so that as X increase MRS decreasing.

Economics 3070
Fall 2014

c. U(x, y) =

x2 + y2
y
5
4
3

U =5
3

Since the indifference curves are not bowed towards the origin, they do not obey the
assumption of diminishing MRS. Alternatively, we know MUx is positive and MUy
is positive, so as quantity of X increases, the quantity of Y must decrease.
The MRSxy = X/Y . So as X increases the numerator increases so MRS increases.
As X increases Y decreases so denominator is getting smaller and MRS increases.
Both these effects work in the same direction so MRS is increasing not diminishing.
d. U(x, y) =

x2 y2
y

U =4
2 5
3

This one is a bit trickier because the indifference curves are not downward sloping.
We want to check whether it is the case that as x increases, MRSx,y decreases. We
begin by calculating MRSx,y :

Economics 3070
Fall 2014

MRS x , y =

MU x
MU y
1 / 2

x (x 2 y 2 )

1 / 2

y (x 2 y 2 )

x
y

The next thing we do is substitute for y using the equation of the indifference curve
so as to have MRSx, y expressed solely in terms of x.
The equation of the indifference curve is

U = x2 y2 ,
where U represents a constant level of utility. Solving this equation for y gives us

U 2 = x2 y2
y2 = x 2 U 2
y = x 2 U 2
Substituting for y in our expression for MRSx, y yields

MRS x , y =
=

x
y
x
x 2 U 2

As x approaches U , the denominator goes to 0, which means that MRSx, y goes to

. However, as x goes to , MRSx, y goes to -1. So, as x increases, MRSx, y becomes
larger.
Hence, MRS x , y is not diminishing.

Economics 3070
Fall 2014

e. U(x, y) = x 2 / 3 y 1/ 3
y

512
8
1

U =8
1

512

Since the indifference curves are bowed towards the origin, they do obey the
assumption of diminishing MRS.
f. U(x, y) = log x + log y
Note: log was intended to represent the natural logarithm (i.e., log = ln).
y

e
1

U =1
1

Since the indifference curves are bowed towards the origin, they do obey the
assumption of diminishing MRS.

Economics 3070
Fall 2014

2. Suppose a consumers preferences for two goods can be represented by the CobbDouglas utility function U(x, y) = A x y , where A, , and are positive
constants.

a. What is MRSx, y ?
We begin by calculating the marginal utilities with respect to x and y :

MU x =

U (x , y )
x

MU y =

= A x 1 y

U (x , y )
y

= A x y 1

We can then use these marginal utilities to obtain MRSx, y :

MRS x , y =

MU x
MU y

A x 1 y
.
=
A x y 1
=

y
x

Economics 3070
Fall 2014
b. Is MRSx, y diminishing, constant, or increasing as the consumer substitutes x
for y along an indifference curve?
To determine this, we need to substitute for y using the equation of the indifference
curve so as to have MRSx, y expressed solely in terms of x.
The equation of the indifference curve is

U = Ax y ,
where U represents a constant level of utility. Solving this equation for y gives us

y =

U
Ax
1

U
y =

A x

y=

A x

Substituting for y in our expression for MRSx, y yields

MRS x , y =

y
x

1 U
=

x 1
A x

U
=
A

1

1+
x

Since A, , and are positive constants, the first two terms in the equation above
are also positive and constant. Moreover, the exponent on x, 1 + , is also positive
and constant. Therefore, as x increases, MRS x , y decreases.
That is, MRS x , y is diminishing.

Economics 3070
Fall 2014
c. On a graph with x on the horizontal axis and y on the vertical axis, draw a
typical indifference curve. Indicate on your graph whether the indifference
curve will intersect either or both axes.
We know more is better because MUx and MUy are both positive; therefore, the
indifference curves must be downward sloping. Moreover, we determined in part b
that MRS x , y is diminishing; therefore, the indifference curves must be bowed in
towards the origin.
And finally, recall that the equation of a typical indifference curve is given by

U = Ax y ,
where U represents a constant level of utility. Since for any U > 0, it cannot be the
case that either x or y equals zero, the indifference curves do not intersect either axis.
These three observations indicate that the indifference map must be as follows:
y

U2
U1
x

Economics 3070
Fall 2014

3. Ch 3, Problem 3.6
For the following sets of goods draw two indifference curves, U1 and U2, with
U2 > U1. Draw each graph placing the amount of the first good on the horizontal
axis.
a. Hot dogs and chili (the consumer likes both and has a diminishing marginal
rate of substitution of hot dogs for chili)
Chili

U2
U1
Hot Dogs
b. Sugar and SweetN Low (the consumer likes both and will accept an ounce of
SweetN Low or an ounce of sugar with equal satisfaction)
SweetN Low

Slopes = -1

U1

U2
Sugar

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Fall 2014
c. Peanut butter and jelly (the consumer likes exactly 2 ounces of peanut butter
for every ounce of jelly)
Jelly

U2

U1
2 4

Peanut Butter

d. Nuts (which the consumer neither likes nor dislikes) and ice cream (which
the consumer likes)
Ice Cream

U2
U1

Nuts

Economics 3070
Fall 2014
e. Apples (which the consumer likes) and liver (which the consumer dislikes)
Liver
U1
U2

Apples

4. Repeat Problem 2 for the quasi-linear utility function U (x , y ) = 2 x + y .

We begin by calculating the marginal utilities with respect to x and y :

MU x =
=

U (x , y )
x

MU y =

1
x

U (x , y )
y

=1

We can then use these marginal utilities to obtain MRSx, y :

MRS x , y =
=

MU x
MU y
1
x

Unlike Problem 2, this problem does not require us to substitute for y in order to
determine whether or not MRSx, y is diminishing. (The reason is that y does not appear in
our expression for MRSx, y .) We can just look at our expression for MRSx, y and see that
as x increases, MRSx, y decreases. Therefore, MRSx, y is diminishing.
To summarize, we know more is better because MUx and MUy are both positive;
therefore, the indifference curves must be downward sloping. Moreover, we determined
that MRS x , y is diminishing; therefore, the indifference curves must be bowed in
towards the origin.

Economics 3070
Fall 2014
And finally, note that the equation of a typical indifference curve is given by

U =2 x + y,
where U represents a constant level of utility. Unlike the indifference curves we
examined in Problem 2, the indifference curve represented by the equation
U = 2 x + y do allow for x or y to equal zero: for any U > 0 , we can either set x = 0
(in which case y = U ) or set y = 0 (in which case x = U 2 4 ). Therefore, the
indifference curves in this problem intersect both axes.
These three observations indicate that the indifference map must be as follow.
y

U1

U2
x

5. Julie has preferences for food, F, and clothing, C, are derived by a utility function
U(F,C)=FC. Food costs $1 a unit and clothing costs $2 a unit. Julie has $12 to
spend on food and clothing.
a. Give the equation for Julies budget line. What is the slope of the budget line?

Pc
= !2
Pf
b. Graph Julies budget line. Place food on the vertical axis and clothing on the
horizontal axis.
Julies budget equation is: F + 2C = 12, slope = - !

c. On the same graph, draw an indifference curves that is tangent to his budget
line.
F
12

Economics 3070
Fall 2014

d. Julie is a utility maximize, write the objective function.

e. Write down the full optimization problem with the objective function and the
constraint.
Her objective function is her utility function U(F,C)=FC
d. Using calculus and algebra, find the basket of food and clothing that
maximizes Julies utility (i.e. solve the maximization problem you wrote down
in e) (Assume Julie can purchase fractional amounts of both goods.)

Max U (F, C) =FC

C,F

s.t. F+2C=12

Step 1: using the budget constraint solve for F or C: F=12-2 C

Step 2: Substitute the budget constaint into the utility function so the utility function is a
function of one good.

MAX U(C)=(12-2C)C=12C-4C 2
C

Step 3: Now we need to maximize U with respect to C.

!U
= 12 " 4C = 0
!C
C=3
Step 4: Sub C back into budget constraint to figure out optimal F
F+2(3)=12 so F=6
The basket which optimizes Julies utility funtion is C=3 and F=6.

Economics 3070
Fall 2014
6. Each day Peter, who is in the third grade, eats lunch at school. He only likes
liver (L) and onions (N), and these provide him a utility of

U (L , N ) = ln(LN ).
Liver costs $4.00 per serving, onions cost $2.00 per serving, and Peters mother
gives him $8.00 to spend on lunch.
a. Give the equation for Peters budget line. What is the slope of the budget
line?
Peters budget line is 4L + 2N = 8. The slope of the budget line is PN/PL = 1/2.
b. Graph Peters budget line. Place the number of liver servings on the vertical
axis and the number of onion servings on the horizontal axis.
L
2
Slope = -

c. On the same graph, draw several of Peters indifference curves, including one
that is tangent to his budget line.
L
2

U3
U2

U1
4

Economics 3070
Fall 2014
d. Using calculus and algebra, find the basket of liver and onions that
maximizes Peters utility. (Assume Peter can purchase fractional amounts of
both goods.) Mark this basket on your graph.
REMEMBER YOU MAY NOT SOLVE THE PROBLEM THE WAY THE
BOOK DOES, YOU MUST SET UP THE MAXIMIZATION PROBLEM
AND SOLVE THAT
1. Set up the Maximization Problem
MaxU ( L, N ) = ln( LN )
L, N

s.t.

4L + 2 N = 8

Economics 3070
Fall 2014
2. Rewrite budget constraint so N is in terms of L and L in terms of N
N = 4 - 2L
3. Sub the rewritten budget constraint back into the objective function and rewrite
the maximization.

MaxU ( L) = ln ( L *(4 2 L) )
L

4. Maximize the utility function with respect to L. To do this you need to find the
slope of the utility function (take the derivative w.r.t L) and set the slope equal to ).
Hint before you do this you want to expand the utility function to be ln( 4L -2L2 ).

U
1
=
*(4 4 L) = 0
L L(4 2 L)
4 4L
=0
L(4 2 L)
4 4L = 0
L* = 1
5. To find N*, sub L* back into the budget constraint.
N=2 2(1)
N* = 2
Therefore the optimal bundle is (L* , N* )= (1 , 2).
Therefore, the optimal basket is (L , N ) = (1, 2 ) . The optimal basket is marked in
the figure below:
L
2

Optimal Basket

U3
U2

U1
2

Economics 3070
Fall 2014
7. Ch 4, Problem 4.4
Jane likes hamburgers (H) and milkshakes (M). Her indifference curves are
bowed in and toward the origin and do not intersect the axes. The price of a
milkshake is $1 and the price of a hamburger is $3. She is spending all her
income at the basket she is currently consuming, and her marginal rate of
substitution of hamburgers for milkshakes is 2. Is she at an optimum? If so,
show why. If not, should she buy fewer hamburgers and more milkshakes, or the
reverse?
Note: here we have to use the tangency condition since we are not given enough
information for consumer optimization.
From the given information, we know that PH = 3, PM = 1, and MRSH,M = 2. Comparing
the MRSH,M to the price ratio,

MRS H , M = 2 <

PH 3
= .
PM 1

Since these are not equal, Jane is not currently at an optimum. In addition, we can say
that

PH
MU H
,
> MRS H , M =
PM
MU M
which is equivalent to

MU M MU H
.
>
PM
PH
That is, the bang for the buck from milkshakes is greater than the bang for the buck
from hamburgers. So Jane can increase her total utility by reallocating her spending to
purchase fewer hamburgers and more milkshakes.

Economics 3070
Fall 2014
8. Ch 4, Problem 4.7
Toni likes to purchase round trips between the cities of Pulmonia and Castoria
and other goods out of her income of $10,000. Fortunately, Pulmonian Airways
provides air service and has a frequent-flyer program. A round trip between the
two cities normally costs $500, but any customer who makes more than 10 trips a
year gets to make additional trips during the year for only $200 per round trip.
a. On a graph with round trips on the horizontal axis and other goods on the
vertical axis, draw Tonis budget line. (Hint: This problem demonstrates
that a budget line need not always be a straight line.)
Let Y represent the quantity of other goods Toni purchases and let PY represent
the price of a unit of other goods.
If Toni spends her entire income of $10,000 on other goods, she will obtain
10,000/PY units of other goods. This gives us the Y intercept of the budget line.
But what happens if Toni spends her entire income on round trip flights (X )?
Toni has to pay $500 per flight for the first 10 flights that she buys, so those 10
flights will cost her $5,000, leaving her with $5,000. How many flights can she buy
with the $5,000 she has left over? After the tenth flight, she can buy additional
flights at $200 per flight. So, she can buy 5,000/200 = 25 additional flights at $200 a
piece.
In sum, if Toni spends her entire income of $10,000 on flights, she will obtain
10 + 25 = 35 flights. This gives us the X intercept of the budget line.
But what happens in between the two intercepts? We know that the slope of the
budget line is PX/PY . So, when 0 X 10, the slope of the budget line is
500/ PY , but when 10 < X 35, the slope of the budget line is 200/ PY . The
change in slope generates the kink in the budget line at X = 10.
Other Goods (Y)
10,000/PY

Budget Line
5,000/PY

10

35

Round Trips (X)

Economics 3070
Fall 2014
b. On the graph you drew in part a, draw a set of indifference curves that
illustrates why Toni may be better off with the frequent-flyer program.
Other Goods (Y)
10,000/PY
Optimal Bundle
5,000/PY

10

35

Round Trips (X)

With the indifference curves drawn on the above graph, Toni is better off with the
frequent flyer program than she would be without it. If there were no frequent flyer
program, the top portion of the budget line would extend straight down to the X
axis instead of becoming flatter towards the bottom, and Toni would be unable to
afford the optimal bundle shown in the graph above.
c. On a new graph draw the same budget line you found in part a. Now draw a
set of indifference curves that illustrates why Toni might not be better off with
the frequent-flyer program.
Other Goods (Y)
Optimal Bundle

10,000/PY

5,000/PY

10

35

Round Trips (X)

With the indifference curves drawn on the graph above, Toni is no better off with
the frequent flyer program than she would be without it. If there were no frequent
flyer program, the top portion of the budget line would extend straight down to the
X axis instead of becoming flatter towards the bottom but given the indifference
curves drawn, this wouldnt affect Tonis choice of bundle.