Econ 604



Econ 604. Problem Set #2. Chapter 3, Problems 3.2, 3.4, 3.5, 3.7

3.2. Suppose the utility function for two goods, X and Y, has the Cobb-Douglas form

utility = U(X,Y) = (XY)1/2

a. Graph the U=10 indifference curve associated with this utility function

[pic]

b. If X = 5, what must Y equal to be on theU=10 indifference curve? What is the MRS at this point?

|X |Y |U |

|5 |20 |100 |

|10 |10 |100 |

|15 |6.666667 |100 |

|20 |5 |100 |

Given U =10, we can write (XY)1/2=10 implies XY = 100. Solving, Y = 100/X. Thus

MRS = -dY/dX = 100/X2 With X=5, MRS = 100/25 = 4.

c. In general, develop an expression for the MRS for this utility function. Show how this can be interpreted as the ratio of the marginal utilities for X and Y.

U(X,Y) = (XY)1/2. Taking the total differential

dU = UXdX+UYdY = .5(Y/X).5dX +.5(X/Y).5dY = 0

Solving the middle equality

dY/dX = -UX/UY

Solving the right most expression

. dY/dX = -Y/X so the MRS = Y/X (the opposite of dY/dX)

. Consider a logarithmic transformation of this utility function

U’ = logU

Where log is the logarithmic function to base 10. Show that for this transformation the U’=1 indifference curve has the same properties as the U=10 curve calculated in parts (a) and (b). What is the general expression for the MRS of this transformed utility function?

U’ = log (XY)1/2 = .5logX + .5logY

Plotting ordered pairs when U’=1 yields

|X |Y |U |logX |logY |U' |

|5 |20 |100 |0.69897 |1.30103 |1 |

|10 |10 |100 |1 |1 |1 |

|15 |6.666667 |100.000 |1.176091 |0.823909 |1 |

|20 |5 |100 |1.30103 |0.69897 |1 |

Obviously indifference curves are the same for each utility function.

One can totally differentiate U’ to obtain the same general expression for the MRS as before:

dU’ = (.5/X)dX + (.5/Y)dY = 0

Solving dY/dX = -Y/X so the MRS = Y/X

3.4 For each of the following expressions, state the formal assumption that is being made about the individual’s utility function.

a. It (margarine) is just as good as the high-price spread (butter).

MRSmb = 1, where m = margarine and b = butter.

b. Peanut butter and jelly go together like a horse and carriage

Peanut butter and jelly are perfect complements. That is

U(peanut butter, jelly) = min{peanut butter, jelly}

Where the terms “peanut butter” and “jelly” refer to servings of each product.

c. Things go better with Coke.

Coca Cola is a complement for all goods. That is, for any good x

Ux, coca cola>0

d. Popcorn is addictive – the more you eat, the more you want.

Popcorn consumption exhibits increasing marginal utility, e.g.,

Upopcorn >0.

e. Mosquitoes ruin a nice day at the beach.

Let the utility of the day at the beach be U(beach)>0. Then the utility of a day at the beach with mosquitoes is U(beach, mosquitoes) = 0. Thus, it must the case the that the marginal utility of a day at the beach just equals the marginal disutility of mosquitoes.

f. A day without wine is like a day without sunshine. The marginal (more precisely the incremental) utility of a “wine” just equals the marginal (incremental) utility of sunshine in a day.

g. It takes two to tango. “tango” dancing and a partner are perfect complements in consumption. U(tango, partner) = min(tango, partner)

3.5 Graph a typical indifference curve for the following utility functions and determine whether they have convex indifference curves (that is, whether they obey the assumption of a diminishing MRS)

a. U = 3X + Y

Here the MRS = -dY/dX = -3. The MRS is a constant, and does not exhibit diminishing MRS

b. U = (XY).5

|X |Y |U |MRS |

|5 |20 |10 |4 |

|10 |10 |10 |1 |

|15 |6.6666667 |10 |0.444444 |

|20 |5 |10 |0.25 |

Here MRS is –dY/dX = X/Y. As seen in the rightmost column of the above table, this does exhibit diminishing MRS

c. U= (X2 + Y2).5

Suppose we confine attention to constant increments of X and a utility level of 28.28.

|X |Y |U |MRS |

|20 |20 |28.284271 |1 |

|15 |23.976 |28.281594 |0.625626 |

|10 |26.455 |28.28192 |0.378 |

|5 |27.836 |28.281494 |0.179624 |

Here the utility function is obviously concave, implying an increasing MRS. More formally,

dU = X(X2 + Y2)-.5dX+ Y(X2 + Y2)-.5dY =0 implies dY/dX = - X/Y. Values are shown in the rightmost column of the above table. Notice that the MRS moves directly with X (Constant increments of X require giving up increasing increments of Y)

d. U= (X2 - Y2).5

Plotting some points

|X |Y |U |MRS |

|20 |17.315 |10.009534 |-1.15507 |

|15 |11.175 |10.005967 |-1.34228 |

|12 |6.63 |10.002155 |-1.80995 |

|11 |4.55 |10.014864 |-2.41758 |

|10 |0 |10 |#DIV/0! |

Graphically

Here, notice the Y is a “bad.” Thus, the slope of the MRS is positive. This does not exhibit diminishing MRS More formally,

dU = X(X2 - Y2)-.5dX- Y(X2 - Y2)-.5dY =0 implies dY/dX = X/Y. Values are shown in the rightmost column of the above table.

e. U = X2/3Y1/3

|X |Y |U |MRS |

|20 |2.5 |10 |0.25 |

|15 |4.45 |10.004165 |0.593333 |

|10 |10 |10 |2 |

|5 |40 |10 |16 |

This is another variant of a Cobb-Douglas function. The function does exhibit diminishing MRS Formally,

dU = (2/3)X-1/3Y1/3)dX+ (1/3) X2/3Y-1/3)dY =0 implies dY/dX = -2Y/X. Values are shown in the rightmost column of the above table.

f. U = log X + log Y. We analyzed this function in problem 3.2(d). Looking the table shown below, it is obvious that the MRS for this function is the same as for 3.5(b).

|X |Y |U |MRS |logX |logY |U' |

|20 |5 |10 |0.5 |1.30103 |0.69897 |1 |

|15 |6.6666667 |10 |0.888889 |1.1760913 |0.8239087 |1 |

|10 |10 |10 |2 |1 |1 |1 |

|5 |20 |10 |8 |0.69897 |1.30103 |1 |

Formally, dU = dX/X + dY/Y = 0

Solving dY/dX = -Y/X

3.7. Consider the following utility functions. Show that each of these has a diminishing MRS, but that they exhibit constant, increasing and decreasing marginal utility, respectively. What can you conclude.

a. U(X,Y) = XY

MRS: dU = YdX + XdY = 0

Implies that dY/dX = -Y/X. This is diminishing.

Utility. Observe that the second order condition for concavity with a two variable function is U110. In the above function U11 = 0, U22 = 0 which implies that utility increases at a constant rate.

b. U(X,Y) = X2Y2

MRS: dU = 2XY2dX + 2YX2dY = 0

Implies that dY/dX = -Y/X. This is the same as above, diminishing.

Utility. In the above function U11 =2Y2 0, U22 = 2X2 and U12 = 4XY. Thus

U11 >0, and U11 U22 - U122 = 4X2Y2 -16X2Y2 ................
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