Lahore School of Economics

BSc II – Section C
Microeconomics Winter 2009
Quiz 2 (B)
Lahore School of Economics
Microeconomics I
Winter Term 2009
Quiz 2: BSc. 2, Section C
Suppose that the price of gasoline has risen by 50%. What happens to a consumer's level of wellbeing given he spends some of his income on gasoline? Diagram the impact of the increase in gas
prices in a commodity space diagram, and show the relevant indifference curves. (Take Gasoline on
X-Axis and “$ on Other goods on Y-Axis”) (5)
Now, if the individual's income rises just enough so that his original consumption bundle exactly
exhausts his income, (this level of income implies the consumer can afford his original consumption
bundle) will the individual purchase more or less gasoline? Is the individual better-off at the higher
price level of gasoline with the higher income level or the original price of gas and income? Use the
same diagram! (5)
Initially, the consumer is on budget constraint BC1, consuming g1 units of gasoline on
indifference curve I1, where M is the individual's income level and P 1 is the price of gasoline.
If only the price of gasoline changes to P 2, the horizontal axis intercept of the budget
constraint moves towards the origin. This is illustrated above by a movement to the budget
constraint BC2. On indifference I2, his level of satisfaction is lower than before.
Now, if the individual's income increases just enough so that his original consumption bundle
exactly exhausts his new budget. However, the slope of the budget constraint (BC 3) that runs
Student Name and Section:
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BSc II – Section C
Microeconomics Winter 2009
Quiz 2 (B)
through his original consumption bundle is steeper due to the higher price of gas. This also
implies that his MRS is less than the ratio of prices. Thus, the individual can attain a higher
level of utility by purchasing less gasoline than g1. The individual is better-off at higher
prices and income than at original levels.
2. Jane lives in a dormitory that offers soft drinks and chips for sale in vending machines. Her utility
function is U = 3SC (where S is the number of soft drinks per week and C the number of bags of
chips per week), so her marginal utility of S is
and her marginal utility of C is
. Soft
drinks are priced at $0.50 each, chips $0.25 per bag.
a. Write an expression for Jane's marginal rate of substitution between soft drinks and chips. (3)
3C C
3S S
b. Use the expression generated in part (a) to determine Jane's optimal mix of soft drinks and chips.
The optimal market basket is where
Requires 
C .5
S .25
 2, C = 2S
Jane should buy twice as many chips as soft drinks.
c. If Jane has $5.00 per week to spend on chips and soft drinks, how many of each should she
purchase per week? (4)
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BSc II – Section C
Microeconomics Winter 2009
Quiz 2 (B)
Jane must satisfy her budget constraint as well as optimal mix.
Her budget constraint is:
where I = income
5.00 = .5S + .25C
But she must also satisfy C = 2S, the optimal mix. Substitute 2S for C into budget constraint
5.00 = .5S + .25(2S)
5 = .5S + .5S
Buy 5 soft drinks.
Question 3
The diagram below depicts the optimal consumption bundles for Marty. When the price of shotgun
shells fall, show the change in consumption. Decompose the change into the income and
substitution effects. Assume Shotgun Shells is a normal good. (5)
Now, assume it is an inferior good. Decompose the change into income and sunstitution effects. (5)
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BSc II – Section C
Student Name and Section:
Microeconomics Winter 2009
Quiz 2 (B)
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