Econ 100A-Spring 2010
Problem Set 1 Answers
Department of Economics
University of California, Berkeley
PROBLEM SET 1 ANSWER SHEET
TRUE or FALSE and EXPLAIN
For each statement below, decide whether it is true or false, and
explain the reasoning behind your answer in a few sentences
When appropriate, provide a diagram.
Theresa likes coffee from Starbucks and bagels from Noah's, but only together in specific proportions, and
so her marginal rate of substitution between coffee and bagels is constant.
Theresa’s indifference curves are L-shaped with the corner located where the two goods—coffee
and bagels—are in the desired proportions.
Accordingly, her “MRS of coffee for bagels” is zero or
infinite depending on whether there are too many or too few bagels relative to cups of coffee given her
At the corner, the MRS is undefined because the slope of the indifference curve is
not defined. In any case, her MRS is not constant; that is indicative of perfect
Since Jennifer’s income elasticity of demand for potatoes is negative, she violates the assumption of “more
False. Negative income elasticity means potatoes are an
but that does not mean she
prefers less to more.
It does say that when her income increases, she will consume less potatoes, but
her consumption of goods other than potatoes will increase.
Joaquin buys life insurance but also is known to play the lottery regularly, and so he cannot be an expected
This question is open ended, if only because it does not give details on whether the lottery and
the life insurance constitute a fair bet, a sub-fair bet or a super-fair bet.
Invariably, gambling favors
“the house” so we could assume the lottery is a sub-fair bet, which Joaquin would play only if he is risk
The life insurance policy could go either way. If Joaquin is in much better health and takes all
the precautions (no ski diving or base jumping), then the average policy may be super-fair for him—if
he somehow places a dollar-value on losing his life.
We could imagine that Joaquin’s utility function exhibited both risk loving behavior (i.e., increasing
MU of income, convex) over some final income levels and risk aversion (i.e., decreasing MU of
income, concave) over others.
For example this occurs with the cubic utility that we discussed in
lecture: u(I) = (100 + I)
It is possible that expected utility for a utility function like this could result
in a higher level of expected utility if Joaquin both played the lottery and purchased insurance
compared to doing one, or the other, or neither. Notice that, if in addition to the assumption of
expected utility maximization, we assume Joaquim is
risk loving or risk averse, then
gambling and insuring could not occur.
(Behavioral economics has other explanations for such behavior that does not impose expected utility