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4-Discussion Questions- Solutions

4-Discussion Questions- Solutions - Lecture 4 Consumer...

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Lecture 4: Consumer Theory (II) Suggested questions and exercises (Pindyck and Rubinfeld, Ch.4). Questions: 2, 3a, 3b, 5, Exercises: 5, 7, 9 QUESTIONS 2. Suppose that an individual allocates his or her entire budget between two goods, food and clothing. Can both goods be inferior? Explain. 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. 3. Explain whether the following statements are true or false. a. 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 P 1 P 2 MRS . 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. b. The level of utility increases as an individual moves downward along the demand curve. 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. 5. Which of the following combinations of goods are complements and which are substitutes? Could they be either in different circumstances? Discuss. a. 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 substitutes. b. tennis balls and a tennis racket
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Tennis balls and a tennis racket are both needed to play a game of tennis, thus they are complements.
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