ECON 502 Ch.

5 - Practice Questions
Question 1
Thirsty Ed drinks only pure spring water, but he can purchase it in two dierent-sized containers: 0.75 liter and 2 liter. Because the water itself is identical, he regards the two goods as perfect substitutes. a) Assuming Eds utility depends only on the quantity of water consumed and that the containers themselves yield no utility, express this utility function in terms of quantities of 0.75L containers (x ) and 2L containers (y). b) State Eds demand function for x in terms of px , py , and I. c) Graph the demand curve for x, holding I and py constant. d) How do changes in I and py shift the demand curve for x ? e) What would the compensated demand curve for x look like in this situation? Now suppose Ed has $18 to spend on water, and current prices are px = $1.00 and py = $2.25. However, there is a sale on this week: If you buy three 0.75L containers of water at the regular price, you get one additional 0.75L container for free. f) During the sale, how many 0.75L containers of water will Ed buy? g) Now suppose the sale ends. How many 0.75L containers of water will Ed purchase?

Questions 2
David gets $3 per week as an allowance to spend any way he pleases. Because he likes only peanut butter and jelly sandwiches, he spends the entire amount on peanut butter (at $0.05 per ounce) and jelly (at $0.10 per ounce). Bread is provided free of charge by a concerned neighbor. David is a particular eater and makes his sandwiches with exactly 1 ounce of jelly and 2 ounces of peanut butter. He is set in his ways and will never change these proportions. a) How much peanut butter and jelly will David buy with his $3 allowance in a week? b) Suppose the price of jelly were to rise to $0.15 per ounce. How much of each commodity would be bought?

c) By how much should Davids allowance be increased to compensate for the rise in the price of jelly in part (b) above? d) Carefully graph your results in parts (a), (b) and (c).

Question 3
Suppose the utility function for goods x and y is given by: U (x, y) = xy + y a) Calculate the uncompensated demand functions for x and y. b) Calculate the expenditure function. c) Use the expenditure function calculated in part (b) to compute the compensated demand functions for goods x and y.

Question 4
Suppose the utility function for goods x and y is given by: U (x, y) = x0.3 y 0.7 a) Show that the Slutsky equation holds for this case. b) Suppose that px = $20 and py = $30, and that the consumer has income= $3, 000. If px rises to $25, what is the total substitution eect?

Question 5
Consider a simple quasi-linear utility function: U (x, y) = x + ln y a) Calculate the income eect for each good. Also calculate the income elasticity of demand for each good. b) Calculate the substitution eect for each good. Also calculate the compensated own-price elasticity of demand for each good. c) Show that the Slutsky equation applies to this function.