Lecture 4: Consumer Theory (II)
Suggested questions and exercises (Pindyck and Rubinfeld, Ch.4).
Questions: 2, 3a, 3b, 5,
Exercises: 5, 7, 9
Suppose that an individual allocates his or her entire budget between two goods, food
Can both goods be inferior?
If an individual consumes only food and clothing, then any increase in income must be
spent on either food or clothing (recall, we assume there are no savings).
If food is an
inferior good, then, as income increases, consumption falls.
With constant prices, the
extra income not spent on food must be spent on clothing.
Therefore, as income
increases, more is spent on clothing, i.e. clothing is a normal good.
For both types of
goods, normal and inferior, we still assume that more is preferred to less.
Explain whether the following statements are true or false.
The marginal rate of substitution diminishes as an individual moves
downward along the demand curve.
This is true.
The consumer will maximize his utility by choosing the bundle on his
budget line where the price ratio is equal to the MRS. Suppose the consumer chooses
the quantity of goods 1 and 2 such that
As the price of good 1 falls, the
price ratio becomes a smaller number and hence the MRS becomes a smaller number.
This means that as the price of good 1 falls, the consumer is willing to give up fewer
units of good 2 in exchange for another unit of good 1.
The level of utility increases as an individual moves downward along the
This is true.
As the price of a good falls, the budget line pivots outwards and the
consumer is able to move to a higher indifference curve. One quick way to see that he
is not worse off is the fact that his previous optimal bundle is still affordable as the
price of one good decreases.
Which of the following combinations of goods are complements and which are
Could they be either in different circumstances?
a mathematics class and an economics class
If the math class and the economics class do not conflict in scheduling, then the classes
could be either complements or substitutes.
The math class may illuminate economics,
and the economics class can motivate mathematics.
If the classes conflict, they are
tennis balls and a tennis racket