Problem Set 4
1. A consumer’s preference between two commodities is represented by the utility function
𝑈(𝑥1 , 𝑥2 ) = 𝑥1 3 𝑥2 4 . 𝑥1 and 𝑥2 represent the amount consumed of the two goods.
The prices of good 1 and 2 are 𝑝1 and 𝑝2 per unit respectively. Ram’s income is M.
(a) Derive the Marshallian demand functions for good 1 and good 2.
(b) Derive the indirect utility function.
(c) How do prices and income affect Marshallian demand function and indirect utility function?
3 4
(d) Suppose we consider a different utility function: function: 𝑊 (𝑥1 , 𝑥2 ) = 𝑥1 (7) 𝑥2 (7) . What will
be the Marshallian demand functions for these two commodities under this new utility function.
Will there be any change? Explain your answer carefully.
2. Consider an individual with the following utility function defined over two commodities:
𝑈 (𝑥1 , 𝑥2 ) = min(𝑎𝑥1 , 𝑏𝑥2 )
(a,b>0 and 𝑥1 & 𝑥2 are the quantity consumed of the two goods)
a) What can you say regarding the relation between the two commodities?
b) Derive the Marshallian demand functions for two commodities. Derive the indirect utility
function.
c) Suppose I denote the Marshallian demand function as x1∗ (P1 , P2 , M) and x2∗ (P1 , P2 , M).
Now I define Marshallian budget share for ‘i’th commodity in the following way:
Pi xi∗ (P1 , P2 , M)
si (P1 , P2 , M) = ; i = 1,2
M
Show that the Marshallian budget shares for both the commodities are independent of income.
(This question has a connection with an interesting property of preference. I will discuss about it
deatail in the coming classes).
3. Think of the following utility function defined over two commodities(good 1 and 2):
𝑈 (𝑥1 , 𝑥2 ) = max(𝑥1 , 𝑥2 )
(𝑥1 & 𝑥2 are the quantity consumed of the two goods)
Suppose the prices of the good 1 and good 2 are Rs. 2 and Rs. 3 per unit respectively and
the income is Rs. 120.
Derive the optimal consumption bundle. Explain your answer carefully.
4) Again consider the preference ordering of the drunkard (lexicographic preference) as given in
question 3 in Problem Set 2. What do you think will be the optimal consumption bundle for that
drunkard with any given prices and income. Explain carefully.
5) Consider an individual’s preference between two commodities. The individual only cares
about the sum of the amount of two commodities but consider commodity 1 as 2 times more
important than commodity 2 (in other words, the individual ready to sacrifice 2 units of
commodity 2 to get unit of commodity 1).
a) Write down a suitable utility function that represent the above individual’s preference
between these two commodities.
b) The prices of good 1 and 2 are 𝑝1 and 𝑝2 per unit respectively and the income is M.
Derive the Marshallian demand function for both the commodities. (Hint: Consider
different situations depending on the MRS and price ratio as I have not said anything
specifically about prices. Think about the solution graphically also)
6) Consider a consumer with the following utility function defined over two commodities
(commodity 1 and commodity2): 𝑈(𝑥1 , 𝑥2 ) = 𝑣(𝑥1 ) + 𝑥2 (𝑥1 and 𝑥2 are the amount
consumed of commodity 1 and commodity 2 respectively). The prices of the two commodities
are 𝑃1 and 𝑃2 respectively and the income of the consumer is M.
a) What restrictions on 𝑣 (𝑥1 ) ensure that the indifference curves corresponding to the
utility function 𝑈 (𝑥1 , 𝑥2 ) is downward sloping as well the marginal rate of substitution is
diminishing?
b) Assume 𝑣(𝑥1 ) = 𝑙𝑛𝑥1 . Derive the Marshallian demand functions for commodity 1 and
commodity 2.
c) Derive the indirect utility function. What happens to indirect utility function if income
and all prices increase at the same proportion (say some number 𝑡 > 0). Explain from the
indirect utility function that you have derived in this question.
7. The utility function for a consumer is
𝑈 (𝑥1 , 𝑥2 ) = min(𝑥2 + 2𝑥1 , 𝑥1 + 2𝑥2 )
a) Draw the indifference curve for 𝑈 (𝑥1 , 𝑥2 ) = 20. Shadow the area where 𝑈 (𝑥1 , 𝑥2 ) ≥ 20.
b) What can you say about the optimal consumption bundle?
