Unformatted text preview: d plug this into the utility perfect do the same with Y = 0 and By
line to solve for the two utility is greater.
which is goods.
For example, let U ( x, y) = min{ x, y}, ( Px , Py , I ) = (50, 200, 1000), and A = B = 1. At the optimum, we
6 4 are supposed to have x = y. We can plug this into the budget line:
50x + 200y = 1000 )
)
)
) 50x + 200x = 1000
250x = 1000
x=4
y=4 So the optimal bundle is ( x, y) = (4, 4). See Figure 5 to see this graphically.
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< BD Figure 5: An Example with Perfect Complements.
!" Figure 7: An example with perfect complements. 3.2 Corner Solutions A corner solution describes an optimal bundle in which at least one good is not being consumed. The
tangency condition (6) may not hold at a corner solution. The usual method of solving the consumerâ€™s
problem is to check whether the tangency condition (6) holds for any positive x and y. If no such point
exists, check the corners: set x = 0, use the budget line to solve for y and plug this into the utility function;
do the same with y = 0 and see which is utility is greater.
Example: Perfect Substitutes
Let U ( x, y) = x + y and ( Px , Py , I ) = (50, 200, 1000). The price ratio is
bundles ( x, y). It is clear that the tangency condition cannot hold.
9 Px
Py = 1
4
and the MRSxy = 1 for all â€¢ Lets check the corner solution for x = 0. The consumer spends all her money on y so y =
5 so she gets utility U (0, 5) = 5. â€¢ If y = 0, then x = 1000
50 I
Py = 1000
200 = = 20 and U (20, 0) = 20. Therefore the consumerâ€™s optimal bundle is (20, 0).
This method is a brute force method of solving for the optimal bundle. Using a bit of economic intuition
can sometimes help you skip to the end. You may have notice that both x and y have marginal utility of
1 but y costs 4 times as much as x. No rational consumer would buy any y. To see this, imagine two gas
stations right next to each other, one offers gas at $1 per litre and one offers gas at $4 per litre. Which station
would you choose? More formally, good x gives 1/50 units of marginal utility per dollar while good y gives
only 1/200 units of marginal utility per dollar. This indicates that good x is the better buy. See P. 112 in
your text to see how this measurement (marginal utility per dollar) relates to the tangency condition.
A third method of looking for corner solutions is to draw the budget line and indifference curve. See
Figure 6 for this. Recall that as the indifference curves move out from the origin they represent higher and
higher utility.
5 1/200 units of marginal utility per dollar. This indicates that good X is the better buy. See
page 112 in your text to see how this measurement (marginal utility per dollar) relates to
the tangency condition.
A third method of looking for corner solutions is to draw the budget line and indiâ†µerence
curve. See Figure 6 for this. Recall that as the indiâ...
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 Summer '13
 Microeconomics, py, Corner Solutions

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