Chapter-2: BUDGET CONSTRAINT

Q1 Originally the consumer faces the budget line p1x1 + p2x2 =

m. Then the price of good 1 doubles, the price of good 2 becomes
8 times larger, and income becomes 4 times larger. Write down an
equation for the new budget line in terms of the original prices
and income.

Q2. What happens to the budget line if the price of good 2

increases, but the price of good 1 and income remain constant?

Q3. If the price of good 1 doubles and the price of good 2 triples,
does the budget line become flatter or steeper?

Q4. What is the definition of a numeraire good?

Q5. Suppose that the government puts a tax of 15 cents a gallon

on gasoline and then later decides to put a subsidy on gasoline at
a rate of 7 cents a gallon. What net tax is this combination
equivalent to?

Q6. Suppose that a budget equation is given by p1x1 + p2x2 = m.

The government decides to impose a lump-sum tax of u, a
quantity tax on good 1 of t, and a quantity subsidy on good 2 of s.
What is the formula for the new budget line?

Q7. If the income of the consumer increases and one of the prices
decreases at the same time, will the consumer necessarily be at
least as well-off?

Chapter-3: PREFERENCES

Q1. If we observe a consumer choosing (x1,x2) when (y1,y2) is

available one time, are we justified in concluding that (x1, x2)
(y1, y2)?

Q2. Consider a group of people A, B, C and the relation “at least

as tall as,” as in “A is at least as tall as B.” Is this relation
transitive? Is it complete?

Q3. Take the same group of people and consider the relation
“strictly taller than.” Is this relation transitive? Is it reflexive? Is
it complete?
Q4. A college football coach says that given any two linemen A
and B, he always prefers the one who is bigger and faster. Is this
preference relation transitive? Is it complete?

Q5. Can an indifference curve cross itself? For example, could

Figure 3.2 depict a single indifference curve?

Q6. Could Figure 3.2 be a single indifference curve if preferences

are mono- tonic?

Q7. If both pepperoni and anchovies are bads, will the

indifference curve
have a positive or a negative slope?

Q8. Explain why convex preferences means that “averages are

preferred to extremes.”

Q9. What is your marginal rate of substitution of $1 bills for $5

bills?

Q10. If good 1 is a “neutral,” what is its marginal rate of

substitution for good 2?

Q11. Think of some other goods for which your preferences might
be concave.

Chapter-4: UTILITY

Q1. The text said that raising a number to an odd power was a
monotonic transformation. What about raising a number to an
even power? Is this a monotonic transformation? (Hint: consider
the case f(u) = u2.)

Q2. Which of the following are monotonic transformations? (1) u

= 2v − 13; (2) u = −1/v2; (3) u = 1/v2; (4) u = In v; (5) u = −e−v;
(6) u = v2; (7)u=v2 for v >0; (8)u=v2 for v< 0.

Q3. We claimed in the text that if preferences were monotonic,

then a diagonal line through the origin would intersect each
indifference curve exactly once. Can you prove this rigorously?
(Hint: what would happen if it intersected some indifference
curve twice?)

Q4. What kind of preferences are represented by a utility function

of the form u(x1, x2) = √x1 + x2? What about the utility function
v(x1, x2) = 13x1 + 13x2?
Q5-Q6 = FROM TEXTBOOK

Q7. Can you explain why taking a monotonic transformation of a

utility function doesn’t change the marginal rate of substitution?

Chapter-5: CHOICE

Q1. If two goods are perfect substitutes, what is the demand

function for good 2?

Q2. Suppose that indifference curves are described by straight

lines with a slope of −b. Given arbitrary prices and money income
p1, p2, and m, what will the consumer’s optimal choices look like?

Q3. Suppose that a consumer always consumes 2 spoons of sugar

with each cup of coffee. If the price of sugar is p1 per spoonful
and the price of coffee is p2 per cup and the consumer has m
dollars to spend on coffee and sugar, how much will he or she
want to purchase?

Q4. Suppose that you have highly nonconvex preferences for ice
cream and olives, like those given in the text, and that you face
prices p1, p2 and have m dollars to spend. List the choices for the
optimal consumption bundles.

Q5. If a consumer has a utility function u(x1,x2) = x1x42, what

fraction of her income will she spend on good 2?

Q6. For what kind of preferences will the consumer be just as

well-off facing a quantity tax as an income tax?

Chapter-6: DEMAND

Q1. If the consumer is consuming exactly two goods, and she is

always spending all of her money, can both of them be inferior
goods?

Q2. Show that perfect substitutes are an example of homothetic

preferences.
Q3. Show that Cobb-Douglas preferences are homothetic
preferences.

Q4. The income offer curve is to the Engel curve as the price offer
curve is to ...?

Q5. If the preferences are concave will the consumer ever

consume both of the goods together?

Q6. Are hamburgers and buns complements or substitutes?

Q7. What is the form of the inverse demand function for good 1 in
the case of perfect complements?

Q8. True or false? If the demand function is x1 = −p1, then the

inverse demand function is x = −1/p1.
Chapter-7: SLUTSKY EQUATION

Q1. Suppose a consumer has preferences between two goods that

are perfect substitutes. Can you change prices in such a way that
the entire demand response is due to the income effect?

Q2. Suppose that preferences are concave. Is it still the case that
the substitution effect is negative?

Q3. In the case of the gasoline tax, what would happen if the
rebate to the consumers were based on their original
consumption of gasoline, x, rather than on their final
consumption of gasoline, x′?

Q4. In the case described in the preceding question, would the

government be paying out more or less than it received in tax
revenues?

Q5. In this case would the consumers be better off or worse off if
the tax with rebate based on original consumption were in effect?

Chapter-9: BUYING AND SELLING

Q1. If a consumer’s net demands are (5,−3) and her endowment

is (4,4), what are her gross demands?

Q2. The prices are (p1,p2) = (2,3), and the consumer is currently
consuming (x1,x2) = (4,4). There is a perfect market for the two
goods in which they can be bought and sold costlessly. Will the
consumer necessarily prefer consuming the bundle (y1 , y2 ) = (3,
5)? Will she necessarily prefer having the bundle (y1, y2)?

Q3. The prices are (p1,p2) = (2,3), and the consumer is currently
consuming (x1, x2) = (4, 4). Now the prices change to (q1, q2) =
(2, 4). Could the consumer be better off under these new prices?

Q4. The U.S. currently imports about half of the petroleum that it
uses. The rest of its needs are met by domestic production. Could
the price of oil rise so much that the U.S. would be made better
off?

Q5. Suppose that by some miracle the number of hours in the day
increased from 24 to 30 hours (with luck this would happen
shortly before exam week). How would this affect the budget
constraint?

Q6. If leisure is an inferior good, what can you say about the
slope of the labor supply curve?

Chapter-11: ASSET MARKET

Q1. Suppose asset A can be sold for $11 next period. If assets
similar to A are paying a rate of return of 10%, what must be
asset A’s current price?

Q2. A house, which you could rent for $10,000 a year and sell for
$110,000 a year from now, can be purchased for $100,000. What
is the rate of return on this house?

Q3. The payments of certain types of bonds (e.g., municipal

bonds) are not taxable. If similar taxable bonds are paying 10%
and everyone faces a marginal tax rate of 40%, what rate of
return must the non-Taxable bonds pay?

Q4. Suppose that a scarce resource, facing a constant demand,

will be exhausted in 10 years. If an alternative resource will be
available at a price of $40 and if the interest rate is 10%, what
must the price of the scarce resource be today?

Chapter-12: UNCERTAINTY

Q1. How can one reach the consumption points to the left of the
endowment in Figure 12.1?
Q2. Which of the following utility functions have the expected
utility property? (a) u(c1, c2, π1, π2) = a(π1c1 + π2c2), (b) u(c1,
c2, π1, π2) = π1c1 + π2c2, (c) u(c1,c2,π1,π2) = π1 lnc1 + π2 lnc2
+ 17.

Q3. A risk-averse individual is offered a choice between a gamble

that pays $1000 with a probability of 25% and $100 with a
probability of 75%, or a payment of $325. Which would he
choose?

Q4. What if the payment was $320?

Q5. Draw a utility function that exhibits risk-loving behaviour for

small gambles and risk-averse behaviour for larger gambles.

Q6. Why might a neighbourhood group have a harder time self-

insuring for flood damage versus fire damage?