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Microeconomic Theory II Pb1

# Microeconomic Theory II Pb1 - Microeconomic Theory II...

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Microeconomic Theory II Problem Set 1 Question 1 The legendary 007 James Bond’s favorite drink is Vodka Martini and he likes it “shaken, not stirred”. This is made by 2 shots of vodka and 4 shots of dry martini, then shaking it with ice in the cocktail shaker till it is iced cold. It is served without ice (“or straight up”). Suppose the vodka costs \$4 per shot and dry martini costs \$2 per shot. Mr. Bond’s allowance from M16 is \$200. (a) Write down Mr. Bond’s utility function (b) Find the Marshallian demands for vodka and for martini for Mr.Bond. (c) If the price of dry martini drops to \$1, calculate and graph the Marshallian demand for dry martini. (d) From (c), calculate the Slutsky substitution effect and income effect. (e) Draw a diagram to show your answers in (d) and graph the Slutsky demand for dry martini. (f) From (c), calculate the Hicks substitution effect and income effect (g) Draw a diagram to show your answers in (f) and graph the Hicksian demand for dry martini (h) Comment on your results in (d) and (f)

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