EC120 Lecture Notes - Lecture 9: Budget Constraint, Indifference Curve, Normal Good

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21 Oct 2015

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Ec120 lecture #9 the theory of consumer choice. Budget determines what is affordable and what is unaffordable. You can buy 250 litres of pepsi: your budget constraint shows the bundles you can afford. *simply take budget, and divide it by price to find out how much you can afford. Let price of pizza = p1, and the price of pepsi = p2, then 1000 = 10 * q1 + 2 * q2: more generally, income = p1 * q1 + p2 * q2. If the entire income is spent on pizza, we can afford. If the entire income is spent on pepsi, we can afford. =500 litres of pepsi: between these two points there are many other bundles, any combination that you can think of as long as you"re spending you"re whole budget. In this case, it would be : quantity of good 1 = always on the x axis. Quantity of good 2 = always on the y axis.

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Given prices for two goods PX = 2 and PY = 3 and a budget of $120 a consumer is trying to maximize the utility function U(X, Y ) = 2X0.3Y 0.7 . Use the Lagrange method to solve this problem, but donât worry about the second order conditions (if you wish, you can actually check that the MRS is decreasing and this utility function is well behaved). a) Write and solve the utility maximization problem subject to the budget constraint. What is the resulting value of the utility function? (U=49.0481) b) Write and solve the dual problem. Do you get the same optimal solution (the same optimal combination of X and Y)? What is the resulting expenditure? Does that match the budget of your original (primal) problem? (X=18, Y=28 should be the same as for a or very close due to rounding) c) Assume now general values for prices and income. Solve for the optimal amounts of X and Y as functions of PX, PY , and I. What conclusion can you draw regarding how you spend your budget when dealing with Cobb Douglas functions with exponents that add up to 1. You can actually try to solve the general case where we replace the exponents 0.3 and 0.7 with some Î± and Î², where Î± + Î² = 1. (Hint: you should find that you spend percent of your income on X and Î² percent of your income on Y. See if you can get there by solving!)

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Microeconomics Multiple choice questions. Please answer all the questions.

1. Scarcity:
A. exists because resources are limited while human wants are unlimited.
B. means we are unable to have as much as we would like to have.
C. will likely be eliminated as technology continues to expand.
D. is not an issue addressed in economics.

2. People are forced to make choices because of:
A. unlimited wants and unlimited resources.
B. limited wants and unlimited resources.
C. unlimited wants and limited resources.
D. limited wants and limited resources.
E. irrational wants and limited resources.

3. Which of the following is closest to the definition of capital?
A. c and e.
B. c and d.
C. Tools, equipment, means of transportation
D. Factories and machinery.
E. Borrowed money.

4. Which one of the following is the most accurate definition of economics?
A. Economics is the study of stocks and bonds.
B. Economics is the study of how people allocate unlimited resources.
C. Economics is the study of how consumers choose to spend their income.
D. Economics is the study of how society chooses to allocate scarce resources.

5. The basic difference between macroeconomics and microeconomics is:
A. microeconomics concentrates on individual markets while macroeconomics focuses primarily on international trade.
B. microeconomics concentrates on the behavior of individual consumers while macroeconomics focuses on the behavior of firms.
C. microeconomics concentrates on the behavior of individual consumers and firms while macroeconomics focuses on the performance of the entire economy.
D. microeconomics explores the causes of inflation while macroeconomics focuses on the causes of unemployment.

6. Which of the following is not a resource?
A. Land.
B. Labor.
C. Money.
D. Capital.

7. Which of the following would an economist classify as capital?
A. 100 shares of Microsoft stock.
B. $50 bill.
C. credit card.
D. lawyer's personal computer.

8. Economics, according to its definition, studies how people:
A. earn and spend money.
B. invest in the stock and bond markets.
C. make choices in the face of scarcity.
D. supply goods in response to demand.

9. Which of the following is the best example of a microeconomic topic?
A. The impact that the money supply has on inflation.
B. The reasons for increases in the price of soft drinks.
C. The effect that federal budget deficits have on the interest rate.
D. The tradeoff between inflation and unemployment.

10. Which of the following is a macroeconomics topic?
A. Wages of textile workers in the Northeast.
B. The cost of producing 10,000 bookcases.
C. The economy's annual growth rate.
D. National demand for fish.
E. Effects of farm subsidies on food prices.

11. An economic theory claims that a rise in gasoline prices will cause gasoline purchases to fall, Ceteris paribus. The phrase "Ceteris paribus" means that:
A. other relevant factors like consumer incomes must be held constant.
B. the gasoline prices must first be adjusted for inflation.
C. the theory is widely accepted but cannot be accurately tested.
D. consumers' need for gasoline remains the same regardless of the price.

12. An economic model is:
A. a plastic scaled version of the economy.
B. a complete depiction of reality.
C. an abstraction from reality.
D. applicable to consumer behavior but not to producer behavior.
E. not an accepted tool of the economics profession.

13. Which of the following sayings best reflects the concept of opportunity cost?
A. "You can't teach an old dog new tricks."
B. "There is no such thing as a free lunch."
C. "I have a baker's dozen."
D. "There's no business like show business."

14. The opportunity cost of watching television is:
A. all of the alternative programs that appear on other stations.
B. zero because there is no money expenditure involved.
C. the alternative use of the time foregone by watching the program.
D. zero if it benefits you.

15. Which of the following does not illustrate opportunity cost?
A. If I study, I must give up going to the football game.
B. If I buy a computer, I must do without a 35" television.
C. More consumer spending now means more spending in the future.
D. If I spend more on clothes, I must spend less on food.

16. When deciding whether to buy a second car, marginal analysis indicates that the purchaser should compare the:
A. benefits expected from two cars with the cost of both.
B. additional benefits expected from a second car with the cost of the two cars.
C. dollar cost of the two cars with the potential income that the cars will generate.
D. additional benefits of the second car with the additional cost of the second car.

17. According to marginal analysis, you should spend more time studying economics if the extra benefit from an additional hour of study:
A. is positive.
B. outweighs the extra cost.
C. exceeds the benefits of the previous hour of study.
D. will raise your exam score.

EC120 Lecture Notes - Lecture 9: Budget Constraint, Indifference Curve, Normal Good

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