Question 1
Match the following descriptions of preferences to the indifference curve diagrams that follow.
Based on the indifference curve chosen, explain your answer for each items focusing on the shape
of the curve.
i.
________
drinks.
Ann does not care whether she has more diet soft drinks or fewer diet soft
ii.
________
Peter is very picky about his buttered popcorn. He tops every quart of
popped corn with exactly one quarter cup of melted butter.
iii.
________
Amy likes M&M's, plain and peanut. For Amy, the marginal rate of
substitution between plain and peanut M&M's does not vary with the quantities of plain
and peanut M&M's she consumes.
iv.
________
to eat it.
v.
________
Natalya likes rap and rock music. Natalya's preferences exhibit a
diminishing marginal rate of substitution between the two types of music.
vi.
________
Matthew knows his limit. He likes beer up to a point, but if he drinks too
much he gets sick.
George dislikes broccoli and would be willing to pay something to not have
(24 marks: 4 marks each)
(Total: 24 marks)
i.
B. In this case, diet sofrdrinks act as a neuter good where the amount of dieat soft drinks
will not affect the amount of satisfaction for Ann. By using the indifferent curve of B, it's
best explain to this situation. Diet soft drinks as a neuter good at x-axis and another normal
good as y-axis. More normal good will give more satisfaction as all consumer prefer more
is better than less. So, the indifferent curve will move upward as the utility is greater.
Neutral good will not affect the level of satisfaction so that the shape of curve will be
horizontal.
ii.
F. If two goods are perfect complements then the indifference curves will be L-shaped.
The consumer’s utility will not increase unless both goods increase in the required
proportion. In this case, Peter is no better off having several quarter of popped corn if he
has only one quarter cup of melted butter. The additional popped corn has zero marginal
utility without additional cup of melted butter, so the bundles of goods differ only in the
number of popped corn he has.
iii.
D. This is the case for goods or bundle of goods which are the plain and peanut M&M's
as the perfect substitutes. The indifference curves are in linear form and will have a
constant slope since Amy is willing to switch the M&M's at a fixed ratio. The marginal
rate of substitution between plain and peanut M&M's is likewise constant.
iv.
A. George is assuming that the broccoli is a bad thing to him because he doesn't like to
have it. So, the indifferent curve will be positively upward slopping. Broccoli will act as
x-axis in the graph. The indifferent curve will move to the left as the broccoli consume
by George will be lesser. If the graph is move toward right, the more broccoli George will
have and this will decrease the level of satisfaction for George.
v.
C. The slope of an indifference curve, known as the marginal rate of substitution, shows
the rate at which consumers are willing to give up one good in exchange for more of the
other good. The indifferent curves between rap music and rock music are convex to the
origin, describing the negative substitution effect. Natalya will prefer to give up fewer rap
music to listen to rock music. This will cause the marginal rate of substitution decreases
as moving down the indifference curves.
vi.
E. Indifferent curve E will best explain this situation. In the front part of the graph, the
indifferent curve is move upward and toward right. It means that more consuming of beer
will give more satisfaction to Matthew. Yet, the part after it will be moving upward and
toward left. It means that more consuming of beer has already decrease the satisfaction
becausw it will cause Matthew fall to sick.
Question 2
Consider Rahim utility function: U (X, Y) = 12 XY, where X and Y are two goods. If the
individual consumed 15 units of X and received 1800 units of utility, how many units of Y must
the individual consume? Would a market basket of X = 10 and Y = 5 be preferred to the above
combination? Explain.
(6 marks)
(Total: 6 marks)
Given that U (X, Y) = 1800, X =15
U (X, Y) = 12 XY
1800 = 12 (15)Y
1800 = 180Y
Y = 10
The individual must consume 10 units of Y in the combination to receive 1800 units of
utility.
Given that X = 10, Y = 5
U (X, Y) = 12 XY
U (X, Y) = 12 (10)(5)
U (X, Y) = 600
Hence, the first combination would be preferred as the unit of utility for the market basket
of X =10, Y =5 is lesser than the previous market basket of X =15 and Y =10.