Chapter 5- Choice

Question 1

Boundary optimum

Answer 1

The optimal consumption involved consuming Zero units of one of the goods. The indifference curve is not tangent to the budget line

exceptions to tangency condition

Question 2

Kinky tastes

Answer 2

Here is an optimal consumption bundle where the indifference curve doesn’t have a tangent.

exceptions to tangency conditions

Question 3

Demand bundle

Answer 3

The optimal choice of goods 1 and 2 at some set of prices and income

Question 4

Demand function

Answer 4

The function that relates the optimal choice – the quantities demanded – to the different values of prices and incomes

X1 (p1, p2, M)
X2 (p1, p2, m)

Question 5

Demand for perfect substitutes

Answer 5

If p1>p2, then the consumer will purchase only good 2

If p2>p1 then the slope of the budget line is flatter than the slope of the IDCs and will choose all of good 1

If p1=p2 any amount of good 1 and 2 that satisfies the budget constraint is optimal (indifferent)

   m/p1                       When p1 0& m/p1   when p1=p2
   0                              When p1> p2

Question 6

Demand for neutrals and bads

Answer 6

In the case of a neutral consumer spends all income on good they like, same in the case of a bad.

If commodity 1 is a good and commodity 2 is a bad, demand functions will be:

X1= m/p1
X2=0

Question 7

Cobb-Douglas demand fictions

Answer 7

U(x1, x2) =x1^c *x2^d

X1=c/(c+d)m/p1 or (cm/(cp1+dp1))
X2=d/(c+d)m/p2 or (d*m/(cp2+dp2))

Fraction of income spent:

On good 1 = c/ (c+d)
On good 2 = D/ (c+d)

Question 8

Optimal Choice

Concave preference

Answer 8

The optimal consumption position where the indifference curve is tangent to the budget line.

If the optimal choice involves consuming some of both goods so that it is an interior optimum, then necessarily the indifference curve will be tangent to our budget line.

MRS=-p1/P2