IIIT Chittoor, AP

Problem Set 1

Principles of Economics

August 2017.

1) Komal has a monthly income of Rs200 that she allocates among two goods: meat and potatoes.

a. Suppose meat costs Rs4 per gm and potatoes Rs2 per gm. Draw her budget constraint.

b. Suppose also that her utility function is given by the equation U(M, P) = 2M + P. What
combination of meat and potatoes should she buy to maximize her utility? (Hint: Meat and
potatoes are perfect substitutes.)

c. Komals supermarket has a special promotion. If she buys 20 kgs of potatoes (at Rs2 per kg), she
gets the next 10 kg for free. This offer applies only to the first 20 kgs she buys. All potatoes in
excess of the first 20 kgs (excluding bonus potatoes) are still Rs2 per kg. Draw her budget
constraint.

d. An outbreak of potato rot raises the price of potatoes to Rs4 per gm. The supermarket ends its
promotion. What does her budget constraint look like now? What combination of meat and
potatoes maximizes her utility?

2) Julio receives utility from consuming food (F) and clothing (C) as given by the utility function U(C,F) =
FC. In addition, the price of food is Rs2 per unit, the price of clothing is Rs10 per unit, and Julios weekly
income is Rs50.

a. What is Julios marginal rate of substitution of food for clothing when utility is maximized?
Explain.

b. Suppose instead that Julio is consuming a bundle with more food and less clothing than his
utility maximizing bundle. Would his marginal rate of substitution of food for clothing be
greater than or less than your answer in part a? Explain.

3) Consider the utility function C H 1

13 23

a) Draw indifference curves for utility levels 1 and 2.

b) Calculate the marginal rate of substitution for this utility function. How does MRS change with C.

c) Represent the budget constraint if income is 27 and the prices of H and C are 3 and 1 respectively.

d) What is the optimal bundle chosen in this case?

e) How will your answer change if the prices of C and H and the income become 2, 6 and 54
respectively?

4) Pari is facing a choice between sushi and mangoes. Her utility function is as follows:

U(m, s)= m+s1/2

Price of mangoes is 1 and price of sushi is p. Calculate the demand for sushi for Pari.