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### ECON100 Tutorial 4

Is the ratio of marginal utilities between the two goods

Rob Pryce

Accessing My Slides

For those who didn’t get the email:

I will put my slides up after Friday tutorials

Plus any other stuff (eg. Excel worksheets)

You still must attend tutorials!

www.robpryce.co.uk/teaching

Question 2

Coffee

The slope of the budget constraint is the relative price of the two goods

D is optimal

C is impossible

At point D, the indifference curve is “tangential” to the budget constraint

B is possible, but not optimal

A is possible, but not optimal

Doesn’t use all available resources

Lies outside of budge constraint, so not affordable

Lies on the highest indifference curve

The slope of the indifference curve is the marginal rate of substitution

The slope is equal to the slope of the budget constraint

But within the budget constraint

A

C

D

B

i3

i2

i1

Ui1 < Ui2 < Ui3

BC

Muffins

Question 3

Marginal Utility

Utility

Diminishing marginal utility

Increasing marginal utility

Amount of good

- Is the increase in one good needed to offset the decrease of the other
- Like coffee and muffins

- MRS = MUx/ MUy

“Price” of 10p coins falls to 5p

5p

coins

20

Income = £1

i4 > i3 > i2 > i1

Optimal point at A

Called a ‘corner solution’

i2

i1

i4

i3

A

10

20

10p coins

Inter-temporal Food Choiceif perfect substitutes

Food this year

10

Income = £1

i4 > i3 > i2 > i1

Optimal point at A

We don’t eat this year

Unrealistic – we need to eat

i2

i1

i4

i3

A

10

20

Food next year

Question 5

This is in the lecture notes (lectures 7 & 8)

If you are having trouble:

Re-read the notes

Read the book

Ask me!

But for now…

Question 5a – Normal Goods

(coffee)

Intuition of substitution effect:

Consumer sees decrease in relative price

So even with the same indifference curve, would shift towards more x

So more x, less y (A to B)

Intuition of income effect:

Consumer is richer, he can buy more

He buys more of x and more of y

Moves from B to C

y

A

C

B

i2

BC2

i1

BC1

x

sub

inc

(muffins)

Question 5b – Muffins are inferior

(coffee)

Intuition for substitution effect:

Relative price has fallen for x

So want more x, less y on same indifference curve

Move from A to B

y

Intuition for income effect:

Income has risen, but x is inferior good

So demand less, move from B to C

Total effect:

Amount of x has increased

But by less than when it was a normal good

B

C

A

i2

BC2

i1

BC1

x

sub

(muffins)

inc (negative)

Question 5c – Muffins are Giffen

(coffee)

Intuition for substitution effect:

Relative price has fallen for x

So want more x, less y on same indifference curve

Move from A to B

Total effect:

Amount of x has decreased after a fall in the price of x

Demand curve upward sloping

y

Intuition for income effect:

Income has risen, but x is giffen good

So demand less, move from B to C

B

C

A

i2

i1

BC1

BC2

x

sub

(muffins)

inc (negative)

For more on this

See this link

Question 6c

A

The slope of the budget constraint is -2

This is equal to –Phamburgers/ Phot dogs

It is also the slope of the indifference curve at the optimum (point A). It is the marginal rate of substitution at point A.

At the optimum, MRS = -Px/Py

Economically, the trade-off between the goods that the individual is willing to undertake (MRS) is the same as the trade-off that the market requires (slope of budget constraint).

Question 7

a) Pm = £2, Pb = £10, Inc = £100

Optimum is point

Z

b) Pm = £2, Pb = £5, Inc= £100

Substitution effect is

Z - X

X - Y

c) Income effect is

Z - Y

c) Total effect is

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