problemset2answerkey - Middle East Technical University...

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Middle East Technical University Spring 2011 Department of Economics ECON 201 Erol Çakmak TA: Osman Değer ANSWER KEY FOR PROBLEM SET #2 Q1: a)Compare points a and c that are on the same indifference curve: c contains more whiskey and more cigars, but still the individual is indifferent between these two bundles. That is, if he is going to have some additional whiskey in his consumption bundle; which is a “bad”, he has to be compensated by additional cigars. Compare points a and b : b is preferred since it contains more cigars and no additional whiskey. [Note: these kinds of indifference curves are not necessarily linear; their defining property is their upward slope.] b) Perfect substitutes on a one-to-one basis. Compare points a and b : Individual is indifferent between (0,1) and (1,0); as long as 1 cigar is replaced exactly by one glass of whiskey this individual is indifferent. Utility is monotonic in both goods, more whiskey or more cigars are preferred to less. Since point c contains more whiskey and same amount of cigars compared to point a , c > a . This kind of indifference curves are linear for sure; they have constant MRS. c) For this individual cigars and whiskey are perfect complements, they have to be consumed in a
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fixed ratio. a ~ b : b has the perfect combination, a has some extra cigars than this perfect combination and these extra cigars are useless. c ~ b : Once again extra whiskey above the perfect combination is useless and does not increase utility. Only if the
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problemset2answerkey - Middle East Technical University...

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