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Tutorial 2

The document discusses consumer choice and utility maximization through various scenarios involving two goods, potatoes and meat, with different pricing structures and promotions. It also explores the utility functions of different consumers, including their budget constraints and preferences for baskets of goods. Additionally, it examines the effects of price changes on demand and the classification of goods as normal or inferior based on consumption patterns.

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24 views2 pages

Tutorial 2

The document discusses consumer choice and utility maximization through various scenarios involving two goods, potatoes and meat, with different pricing structures and promotions. It also explores the utility functions of different consumers, including their budget constraints and preferences for baskets of goods. Additionally, it examines the effects of price changes on demand and the classification of goods as normal or inferior based on consumption patterns.

Uploaded by

officialarooj01
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Tutorial 2: Consumer Choice, Revealed Preference, and

Demand

1. Connie has a monthly income of $200 that she allocates among two goods: potatoes and meat.
Her utility function is given by the equation U ( P, M) = P + 2M.

(a) Suppose potatoes cost $2 per pound and meat $4 per pound. Draw her budget line. What
combination of meat and potatoes should she buy to maximize her utility?
(b) Connie’s supermarket has a special promotion. If she buys 20 pounds of potatoes (at $2 per
pound), she gets the next 10 pounds for free. This offer applies only to the first 20 pounds
she buys. All potatoes in excess of the first 20 pounds (excluding bonus potatoes) are still $2
per pound. Draw her budget line. What combination of meat and potatoes maximizes her
utility? Is Connie better off with the promotion, i.e., does Connie receive higher utility when
there is promotion?
(c) An outbreak of potato rot raises the price of potatoes to $4 per pound. The supermarket
ends its promotion. What does her budget line look like now? What combination of meat
and potatoes maximizes her utility?

2. As shown in the following figure, a consumer buys two goods, food and housing. Assume the
consumer maximizes utility and her preference satisfies the three assumptions (completeness,
transitivity, and more is better). When she has budget line BL1, she chooses basket A. Given
budget line BL2, she chooses basket B, and with BL3, she chooses basket C.

(a) What can you infer about how the consumer ranks baskets A, B, C, and D?
(b) On the graph, shade in the areas that are strictly less preferred to basket B.
(c) On the graph, shade in the areas that are strictly preferred to basket B.

1
3. Hanfei has utility function U ( x, y) = ( x − 2)y where x ≥ 2 and y ≥ 0. The price of x is Px , the
price of y is Py , and Hanfei’s income is I > 2Px .

(a) Write down the utility maximization problem. Derive the equations of the demand functions
for x and y respectively.
(b) Based on the demand functions you derived in part a), how does the consumption of y
change with the price of y (increase, decrease, or does not change)? How does the consump-
tion of y change with the price of x?
(c) Suppose the price of x is 1 and the price of y is 2. Draw the Engel curve of x. Is x a normal
good?

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