Consumer Theory, Producer Theory Problem Set

Student Id. No.
Jindal School of Government and Public Policy

Problem Set- Consumer Theory
Course Name : Intermediate Microeconomics
This question paper has () printed pages (including this page).

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Consumer Theory
Questions:
1. Consider that you have two goods chocolate C and ice cream I. The price of C is pC and the price of I is
p I . The income of the consumer is M. Write out the budget constraint of the consumer. The following
questions are with regard to the budget constraint.
(a) What is the slope of the budget constraint? How do you interpret the slope.
(b) Suppose M changes while pC and p I do not. How does the budget constraint shift? Do the case
for both an increase and decrease in M.
(c) Suppose pC changes while M and p I do not. How does the budget constraint shift? Do the case
for both an increase and decrease in pC
(d) Suppose p I changes while M and pC do not. How does the budget constraint shift? Do the case
for both an increase and decrease in p I
(e) Suppose pC and M changes but p I does not. How does the budget constraint shift? There will be
4 cases to consider in this case. For example one case is, both pC and M increase. Another case is
pC increases but M decreases and so on. How does the budget constraint shift? Do all the 4 cases.
(f) Suppose p I and M changes but pC does not. How does the budget constraint shift? There will be
4 cases to consider in this case. For example one case is, both p I and M increase. Another case is
p I increases but M decreases and so on. How does the budget constraint shift? Do all the 4 cases.
(g) Now suppose all the three M, pC and p I change. How does the budget constraint shift. There will
be 8 cases to consider here. Do all the cases.
(h) Suppose there is a ration on the consumption of chocolates so that the consumer can never buy
¿
more that C chocolates. Graph the new budget constraint.
2. Consider a utility function, U ( x , y ) =x a y 1−a, where 0<a<1. Suppose the consumer has income of Rs.
500 and the prices of the two goods are given by ( p ¿ ¿ x , p y )=(10 , 5) ¿. The consumer wants to choose
End-term Examination – Spring’2024 Page 1
values of (x , y ) such that her utility is maximized. subject to the condition that her total expenditure
cannot exceed her income.
a. Derive the demand functions for x and y . You can use any method you want to.
b. Are goods x and y normal or inferior goods.
c. Now suppose the p x increases to 12. What is the substitution effect and income effect of this
price change. Calculate each.
3. Consider the utility maximization problem U ( x , y ) =x+ y such that 2 x+ y=m and x ≥ 0 and y ≥ 0.
a. What is the demand function of x and y . What method did you use to reach the said demand?
b. Suppose the price of good y increases from 1 to 1.5. What is the substitution and income effect
of this price change.
4. Consider the utility maximization problem U ( x , y ) =min {x , y } such that 2 x+ y=m and x ≥ 0 and y ≥ 0.
a. What is the demand function of x and y . What method did you use to reach the said demand?
b. Suppose the price of good y increases from 1 to 1.5. What is the substitution and income effect
of this price change.
Producer Theory
5. Consider the short run production functionQ=L a K 1−a. What is its marginal product of labour and
average product of labour. Find the optimal amount of labour chosen choose labour to maximize
profits.). What is the associated cost function.
6. Consider the long run product Q=L a K b . What is the marginal product of labour, marginal product of
capital, average product of labour, average product of capital? Verify the relationships between all these
indices. Find the cost function associated with these production function.
7. Suppose the amount of fixed capital is K=100 and there are 4 firms supplying the perfectly competitive
economy, each having access to 25 units of capital. The production function is Q=L a K 1−a with a< 1.
How much of output does each firm produce as a function of price? Find the pirce ranges for which the
firms makes profits or losses. What is the outcome in the long run where capital is variable and firms
can enter the market.
Welfare Analysis

8. What is the intuitive interpretation of the demand and supply curve? How do you use those intuitions to
show that the outcome of the perfectly competitive market is efficient? Use concepts introduced in class
to argue out the same.
9. Suppose there is a perfectly competitive market. The demand function is q d = 100-2p and the supply
function is q s= 2p. Find the equilibrium price and quantity in the market. Find the consumer, producer
and total surplus in equilibrium. Now suppose the government comes in and imposes a price ceiling of
Rs. 20. How does the producer and consumer surplus change? Is there some deadweight loss. If there is
a deadweight loss then how can the government argue in favour of the policy of the price ceiling?
Suppose instead of a price ceiling the government now introduce a quota of 40 units of output? Is the
outcome the same as a price ceiling of Rs. 20? If not argue why.
10. Suppose there is a perfectly competitive market. The demand function is q d= 100-2p and the supply function is
s
q = 3p . Find the equilibrium price and quantity in the market. Find the consumer, producer and total surplus in
equilibrium. Suppose now the government imposes a tax of Rs. 2 per unit of quantity transacted. Find the
equilibrium price and quantity post tax. Find the consumer surplus, producer surplus and deadweight loss post
tax? Argue why both the consumer surplus and producer surplus is lower post tax. If both consumer and
producer surplus is lower post tax, how can the government argue in favour of the tax? Suppose instead of a tax
the government grants a subsidy of Rs. 2 per unit of quantity transacted. Is there a deadweight loss in this case
and if so how much? Argue the mechanism through which deadweight losses arise in subsidies.

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Student Id. No.

Jindal School of Government and Public Policy

Course Name : Intermediate Microeconomics

This question paper has () printed pages (including this page).

End-term Examination – Spring’2024 Page 2

End-term Examination – Spring’2024 Page 3

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