6_Solutions

# 6_Solutions - College of Human Ecology Cornell University...

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College of Human Ecology Cornell University, Ithaca, New York Department of Policy Analysis and Management PAM 200 Intermediate Micro A. Sinan ¨ Un¨ur – Fall 2007 Quiz 6 – Answers September 27, 2007 Q1: Suppose you consider tea and coffee to be perfect substitutes and always derive twice the satisfaction from tea (denoted T ) as you do from coffee (denoted C ). Your utility function is: ( a ) U ( T , C ) = 2 TC ( b ) U ( T , C ) = 2 T + C ( c ) U ( T , C ) = T + 2 C ( d ) U ( T , C ) = min { 2 T , C } Answer : 1b . The fact that tea and coffee are perfect substitutes means your utility function is linear in tea and coffee. Since tea gives you twice the satisfaction as coffee, its coefficient must be two times that of coffee: U ( T , C ) = 2 T + C . Q2: Suppose the price of tea is P T = \$4 / unit and the price of coffee is P C = \$1 / unit. The oppor- tunity cost of every cup of tea (in terms of coffee) is: Answer : 2c . Every time you buy a unit of tea, you have to spend \$4. With those \$4, you could have bought 4 units of coffee.

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