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2.27 LecNotes

# 2.27 LecNotes - TOP4 Tuesday,February19,2008 7:03PM...

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PRACTICE PROBLEMS [1] Problem 2. Marginal Thinking Suppose Rodney Random uses all his income buying quantities of goods A and B, and at his chosen quantities, MU a /P a > MU b /P b . To increase his utility, should Rodney buy more of good A and less of good B, or vice versa? Why? MU/P can be think of as the marginal utility per dollar, ie, the amount of utility you can buy with \$1. (Just like 4 apple / \$2 per apple => you can buy 2 apple with \$1) Problem 1. Indifference Maps Draw your own indifference maps for the following pairs of commodities, using the diagrams at right. Left and right shoes (Perfect compliments) Chevron and Mobil gasoline. (Perfect substitutes) \$5 bills and \$10 bills (Perfect substitutes at fixed ratio) Smog and lemonade (Bad vs Good) Better explanation at: http://www.theshortrun.com/classroom/tutorial/intmicro/consumer%20problem.htm TOP 4 Tuesday, February 19, 2008 7:03 PM 0227 Page 1

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Since MU/P for A is higher than MU/P for B, that means the amount of utility you can get with \$1 from Good A is higher than Good B. Therefore, to incrase his utility, Rodney should buy more of A and less of B. Problem 3. Budget Constraints Conny Mist's indifference map for food and booze, and her initial budget line, are shown at right. A. Find the utility-maximizing bundle Z*. B. Suppose Conny gets food stamps that entitle her to 10 units of free food, but which cannot be used for booze. Draw the new budget line and show that her utility rises compared to part A. 0227 Page 2