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Tutorial Sheet 2

This document is a tutorial sheet for a course on intermediate economic theory and practice. It provides questions to help students understand concepts related to utility maximization and consumer choice theory, including: 1) Deriving demand functions from a Cobb-Douglas utility function and showing the properties of the demand functions. 2) Showing how the marginal rate of substitution decreases with increasing consumption for a specific utility function. 3) Solving for the optimal consumption bundle given prices, income, and a utility function and graphing the indifference curve and budget constraint. 4) Analyzing the effects of changes in prices and income on demand. 5) Defining key concepts like price elasticity, cross

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92 views

Tutorial Sheet 2

This document is a tutorial sheet for a course on intermediate economic theory and practice. It provides questions to help students understand concepts related to utility maximization and consumer choice theory, including: 1) Deriving demand functions from a Cobb-Douglas utility function and showing the properties of the demand functions. 2) Showing how the marginal rate of substitution decreases with increasing consumption for a specific utility function. 3) Solving for the optimal consumption bundle given prices, income, and a utility function and graphing the indifference curve and budget constraint. 4) Analyzing the effects of changes in prices and income on demand. 5) Defining key concepts like price elasticity, cross

Uploaded by

Mwango
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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THE COPPERBELT UNIVERSITY

School of Humanities and Social Sciences


Department of Economics

BS/BSP 210: Intermediate Economic Theory and Practice


Tutorial Sheet 2: Utility Maximization and Choice (Consumer Theory)

1. State the tangency (necessary) rule for utility maximization.


2. Suppose a consumer has a Cobb Douglas utility function of the type;
𝑈 = 𝑋 𝛼 𝑌𝛽
where 𝑋 and 𝑌 represents two goods a consumer can take in and 𝛼 + 𝛽 = 1
a) Find the MRS of the given utility function.
b) Given that 𝑃𝑋 𝑋 + 𝑃𝑌 𝑌 = 𝐼, write down the langragian.
c) Find the Marshallian demand functions for good X and Y and explain what the
langragian multiplier shows.
d) Suppose 𝛼 = 𝛽 = 0.5 write down the demand functions in c) above.
e) Show and interpret that the demand functions obtained in d) above are;
i. decreasing in price (𝑃)
ii. increasing in income (𝐼)
iii. homogenous of degree zero in price and income for both good X and Y.
f) Derive an expression showing maximum utility (indirect utility function) that the
consumer derives from the consumption of the two goods. Note that 𝛼 = 𝛽 = 0.5.
g) Show and interpret that the indirect utility function is;
i. decreasing in (P)
ii. increasing in (Y)
iii. homogenous of degree zero
h) Suppose you are given that 𝑃𝑋 = 1 and 𝑃𝑌 = 4 and income is 𝐾8. Find the value of
the consumer’s maximum utility in f) above.
i) Determine the expenditure function and note that 𝛼 = 𝛽 = 0.5

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j) Show and interpret that the derived expenditure function is;
i. homogenous of degree one
ii. increasing in price (P)
iii. strictly increasing in (U)
3. A consumer’s utility function is given by;
𝑈 = 𝑋 0.2 𝑌 0.8
a) Find the MRS for the given utility function.
b) Show that MRS decreases as consumption of good Y increases.
4. Audrey consumes two goods 𝑥1 and 𝑥2 summarized by the utility function;
𝑈 = 𝑥1 𝑥2
a) What is Audrey’s optimum consumption bundle when the price of good 𝑥1 = 𝐾2
and good 𝑥2 = 𝐾5 and income is 𝐾400.
b) Neatly graph his budget constraint and indifference curve from the answer you’ve
obtained in a). Label the indifference curve as 𝑈1.
c) Assuming the goods are normal goods, graphically show the effects of a fall in price
of good 𝑥1 and explain what the effects mean. (Hint: Show the substitution and
income effect and place good 𝑥1 on the horizontal axis and good 𝑥2 on the vertical
axis).
d) Suppose there was a decrease in income say to K200, what is expected to happen
to the budget constraint. Kindly illustrate.
5. Define the following terms and show the formulas used to calculate them;
a) Price elasticity of demand
b) Cross price elasticity of demand
c) Income elasticity of demand

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6. The demand function for good 𝐴 is given by 𝑄𝐴 = 100 − 2𝑃𝐴 + 0.2𝑌 + 0.3𝑃𝐵 where 𝑃𝐴
is the good’s own price, 𝑌 is income and 𝑃𝐵 is the price of a related good to 𝐴 given as
𝑃𝐴 = 6, 𝑌 = 500 and 𝑃𝐵 = 10.
a) Find the quantity demanded at the given prices of goods and individual income.
b) Calculate and interpret the good’s own price elasticity of demand.
c) Determine whether the related good is substitutable or complementary? Show
and give a reason for your answer.
d) Find the income elasticity of demand and classify good 𝐴. Show and give a reason
for your answer.

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