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problem set 2

# A suppose meat costs 4 per pound and potatoes 2 per

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Unformatted text preview: goods: meat and potatoes. (a). Suppose meat costs \$4 per pound and potatoes \$2 per pound. Draw her budget constraint. (b). Suppose also that her utility function is given by the equation U (M; P ) = 2M + P . What combination of meat and potatoes should she buy to maximize her utility? (Hint: Meat and potatoes are perfect substitutes.) (c). Connie’ supermarket has a special promotion. If she buys 20 pounds of potatoes (at \$2 per pound), s she gets the next 10 pounds for free. This o¤ er applies only to the …rst 20 pounds she buys. All potatoes in excess of the …rst 20 pounds (excluding bonus potatoes) are still \$2 per pound. Draw her budget constraint. Connie has a monthly income of \$200 that she allocates among two goods: meat and potatoes. (d). An outbreak of potato rot raises the price of potatoes to \$4 per pound. The supermarket ends its promotion. What does her budget constraint look like now? What combination of meat and potatoes maximizes her utility? Exercise 13 At USC campus, the price for cookies is \$1.5 and the price for soda is \$1. Three students, Alice, Bob, and Connie have the same budget – \$100 per month – for cookies and soda. However, they have di¤ erent preferences for cookies and soda as follows. (a). Alice’ preferences can be represented by a utility function U (S; C ) = S + 2C . What’ her optimal s s consumption bundle? (b). Bob’ preferences can be represented by a utility function U (S; C ) = minfS; 2C g. What’ his optimal s s consumption bundle? 3 1 s (c). Connie’ preferences can be represented by a utility function U (S; C ) = 2013x 4 y 4 . What’ her optimal s consumption bundle? p Exercise 14 Suppose that Natasha’ utility function is given by u(I ) = 10I , where I represents annual s income in thousands of dollars. (a). Is Natasha risk loving, risk neutral, or risk averse? Explain. (b). Suppose that Natasha is currently earning an income of \$40,000 (I = 40) and can earn that income next year with certainty. She is o¤ ered a chance to take...
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