EC102: CLASS 2
Christina Ammon
Question 1
“Victoria and Albert are fond of vintage records and tapes.
Records cost £20 apiece; tapes cost £4 apiece. Victoria consumes
both records and tapes. Albert consumers only tapes. Hence:
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Victoria’s MRS and Albert’s MRS of records for tapes are both 1/5
Victoria’s MRS of records for tapes is 1/5 and Albert’s is larger than 1/5
Victoria’s MRS of records for tapes is larger than 1/5 and Albert’s is 1/5
Victoria’s MRS of records for tapes is 1/5 and Albert’s is smaller than
1/5
Victoria
 Victoria consumes both goods
 Utility maximization implies:
 MRS (slope of indifference curve)=relative price (slope of BC)
 MRSr,t=MUt/MUr=Pt/Pr and/or Pr*r+Pt*t=Income
Albert
 Albert consumes only tapes
 What would his IC need to look like to want to consume there?
Question 2
 The price of car transport is 30 cents per mile. The price of bus
transport is 60 cents per mile. The marginal utility of Mario’s
last mile of car transportation is 80 utils, and the marginal
utility of his last mile of bus transportation is 150 utils. Hence:
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Mario is currently maximizing his utility
Mario could increase his utility by decreasing his consumption of car
transportation
Mario could increase his utility by increasing his consumption of car
transportation
Question 2
 What do we need to compare?
 His choice is whether to spend his money on either car or bus
 => need to compare utility per cent
 80/0.3 vs. 150/0.6
 Note: actual levels of utility do not matter!
 What would be his optimality condition?
 MRS=relative price
 MU(car)/MU(bus)=0.3/0.6
Deriving the demand curve
 What is the optimal
allocation as prices
change, keeping income
constant
Price changes
 What is the income effect?
 What is the substitution effect?
 What is the effect of a cross-price change on substitutes and on
complements?
 Income decreases – normal good & inferior good
Question 3
 Margaret consumes pasta and baked potatoes. Ingrid says that,
when the price of pasta falls, Margaret’s pasta consumption
increases while her baked potato consumption is unchanged.
Gustav replies that this is not possible as it violates the axioms
of consumer choice:
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Gustav is right because non-satiation is violated by Margaret’s choice
Gustav is right because decreasing MRS is violated by Margaret’s
choice
Gustav is wrong because Margaret’s choice is compatible with all the
axioms
Question 4
 Suppose the price of polyester shirts increases. What happens
to an individual’s demand curve for cotton shirts?
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The demand curve for cotton shirts is unaffected
The demand curve for cotton shirts shifts to the right
The demand curve for cotton shirts shifts to the left
Question 5
Gustav works in the City and consumes wine and other goods.
Ingrid says that, when Gustav receives extra income through a
bonus, he spends it all on the other goods while his wine
consumption is unchanged. Margaret replies that this is not
possible as it violates the axioms of consumer choice:
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Margaret is right because non-satiation is violated by Gustav’s choice
Margaret is right because decreasing MRS is violated by Gustav’s choice
Margaret is wrong because Gustav’s choice is compatible with all the
axioms
Question 5
Question 6
 Suppose that the price of Porto wine was £20 per litre in 2010
and £25 per litre in 2011. Ingrid observes that Margaret’s
consumption of wine rose from 1 litre per month in 2010 to
1.2 litres per month in 2011. Ingrid concludes that Margaret’s
demand for Porto wine has to be upward sloping:
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Ingrid is wrong: given the above information Margaret’s demand for
Porto wine has to be downward sloping
Ingrid is right: given the above information Margaret’s demand for Porto
wine has to be upward sloping
Ingrid is wrong: the above information is not enough to conclude that
Margaret’s demand for Porto is necessarily upward sloping
Question 7
 The city council is planning to introduce donation boxes to be
placed around the city centre so that people would not give
directly to beggars but instead place money in the boxes. The
idea is to make sure that money given to help the beggars will
not end up being used for alcohol and drugs. Instead, the city
council would use the money to provide shelter, food and other
basic services for the beggars:
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This program will necessarily reduce beggars’ consumption of alcohol
and drugs
This program will necessarily leave beggars’ consumption of alcohol and
drugs unaffected
This program will not necessarily reduce beggars’ consumption of
alcohol and drugs
Budget Constraints
Question 7
 The city council is planning to introduce donation boxes to be
placed around the city centre so that people would not give
directly to beggars but instead place money in the boxes. The
idea is to make sure that money given to help the beggars will
not end up being used for alcohol and drugs. Instead, the city
council would use the money to provide shelter, food and other
basic services for the beggars:
•
•
•
This program will necessarily reduce beggars’ consumption of alcohol
and drugs
This program will necessarily leave beggars’ consumption of alcohol and
drugs unaffected
This program will not necessarily reduce beggars’ consumption of
alcohol and drugs
Question 8
“The representation of indifference curves implicitly assumes that
your utility at any given moment is determined entirely by your
present situation, that the past is irrelevant, and that [for example]
your evaluation of a possible job does not depend on the terms of
your current job. The omission of the reference point is a
surprising case of theory-induced blindness, because we so often
encounter cases in which the reference point obviously matters.”
(Daniel Kahneman)
Question 8
 Does the presence of a reference point seem reasonable?
 Does it matter? Does is change how agents behave?
 What happens to the demand curve?
 Are markets still efficient?