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ECO1011B  Basic Microeconomics
2008 Fall by Travis Ng
Problem Set 2
Due Date: Oct 23, 2008 before 1pm
General Instruction: If your answer involves drawing graphs, you have to clearly label the curves and the
variables involved. Clearly specify their units of measure. Make sure your handwriting is readable.
Total: 100 points
1.
[10 points] In each of the questions below you will be asked to plot different budget lines. Please,
show all the relevant information: intercepts, slope of the budget line, etc.
a.
A prisoner has an income of $100/month to spend on books. In the prison, an economics
book costs $10 and a novel costs $20.
i.
What is the monthly budget equation? (Plot with commodity 1 in the
horizontal axis.)
ii.
Suppose due to shortage of novels, the price of novels increases to $25 while
everything else stays the same, what is the new budget line? Plot it in the same
graph.
iii.
Suppose after the change in part ii., the prisoner
’
s income increases to $120,
what is the new budget line? Plot it in a graph.
b.
Mary
’
s happiness depends on the number of leisure hours she has, and the amount of
money she can spend. When she is not working, she is having her leisure. She never saves
her income overnight. Her earns $50 per hour. Plot her daily budge line.
ANSWER:
a. i. Denote e as the no. of econ books, and n as the no. of novels. Then the budget line is:
$100 = $10e + $20n.
a. ii. The new budget line should be $100 = $10e + $25n.
a. iii. The new budget line should be $120 = $10e + $25n.
(a)
(b)
1200
24
Spending ($)
Leisure (hr)
5
10
4
4.8
ii
i
iii
12
n
e
1
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[10 points] Emily has preferences over playing games in an internet cafe, and drinking coffee. She
has $500 to spend per week. Playing for an hour in an internet cafe costs $5. A coffee costs $20
but within a week, if she has purchased more than 5 coffee, she would only pay $16 starting from
the 6
th
cup of coffee.
a.
Carefully (label axis, intercepts, slope) draw Emily’s budget line. Measure cups of coffee
on the horizontal axis and number of hours on net game on the vertical axis of your
graph.
b.
Her preferences are smooth and convex. Moreover we know that at the optimal
consumption bundle, her marginal utility for an extra hour of internet game is 5 and her
marginal utility for an extra cup of coffee is 16. For some set of indifference curves, show,
in your graph, Emily’s optimal consumption bundle. Denote it with x*. Make sure it is
consistent with the information given above and briefly explain why it is so.
c.
Explain, using graphs, whether Emily would have been better off or worse off if the
coffee shop were to offer a discount of just charging 5/6 of the price of a cup of coffee for
any amount of weekly purchase, rather than the current promotion.
ANSWER:
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 Spring '09
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 Microeconomics

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