ECON100 Tutorial 4

1. ECON100 Tutorial 4 Rob Pryce

2. 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

3. Question 1 Coffee Muffins

4. 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

5. Question 3 Marginal Utility Utility Diminishing marginal utility Increasing marginal utility Amount of good

6. Marginal Rate of Substitution • Is the increase in one good needed to offset the decrease of the other • Like coffee and muffins • Is the ratio of marginal utilities between the two goods • MRS = MUx/ MUy

7. Question 4 – Perfect Substitutes 5p coins 20 Income = £1 Any point is optimal 10 10p coins

8. “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

9. 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

10. 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…

11. 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)

12. 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)

13. 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)

14. For more on this See this link

15. Question 6 A

16. 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).

17. 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

18. Question 7 QUANTITIES books magazines a) 5 (£50) 25 (£50) b) 8 10 c) 6 (£30) 35 (£70)

19. Question 7e

20. Question 7e

21. Any Questions? Office hour: Wednesday, 12:30 Email