ECON2010 MICROECONOMIC THEORY TUTORIAL EXERCISE 4

Java Python ECON2010 MICROECONOMIC THEORY

TUTORIAL EXERCISE 4

Question 1

Madam Lim consumes only two goods: Kopi (good x) and Kuih (good y). Her utility over the two goods is given by

U(x, y) = ln x + 2 ln y.

Madam Lim is a retiree and has no income. However, her dutiful daughter-in-law, Priscilla, gives her an allowance every week to spend on the two goods. The price of Kuih remains at $1 each through out this exercise.

(a) In Week 1, Kopi costs $1 each. Madam Lim has an allowance of $36. Find her utility maximising consumption bundle in Week 1. Calculate also the utility she achieves at her optimal consumption bundle. (For now, leave utility in ln(·)).

(b) In a diagram with Kopi on the x-axis and Kuih on the y-axis, draw Madam Lim’s Week 1 budget line. Label the optimal bundle you have found in part (a) and sketch the indifference curve passing through it.

(c) In Week 2, the price of Kopi increases to $2. Suppose Priscilla is still giving Madam Lim $36, how many Kopi and Kuih will Madam Lim consume? Draw the budget line associated with this price and income on your diagram in part (b), and label the consumption bundle you have found.

(d) How much does Priscilla have to give to Madam Lim in Week 2 so that Madam Lim can afford her Week 1 bundle?

(e) Calculate Madam Lim’s utility maximising bundle in Week 2 had she been given the income you found in part (d). Calculate also the utility she achieves at this optimal consumption bundle. Is it higher, lower or the same as the utility you found in part (a)?

(f) How much does Priscilla have to give to Madam Lim in Week 2 so that Madam Lim can attain her Week 1 utility? Is this amount higher than, lower than or equal to the income you have found in part (d)? As you are calculating this amount, find also the consumption bundle Madam Lim will choose in Week 2 if she is given this income.

(g) On the same diagram you have drawn earlier, draw the budget line associated with the part (f) budget. Label the consumption bundle you have found in part (f).

(h) What is the change in amount of Kopi from part (a) to part (c) (i.e., the change associated with a change in price but not money income)? What is the change in amount of Kopi from part (a) to part(f) (i.e., the change associated with a change in price but with a compensation in income to make up the same ut ECON2010 MICROECONOMIC THEORY TUTORIAL EXERCISE 4 ility)? Which of the two changes is larger?

(i) In Week 3, the price of Kopi decreases to $0.5. Suppose Priscilla is still giving Madam Lim $36 (her Week 1 income), how many Kopi and Kuih will Madam Lim consume? On a separate diagram (please don’t draw this on the old diagram — it will be incomprehensible), re-draw the graph of part (b), then draw in the budget line associated with the Week 3 price and the Week 1 income. Label the utility maximising bundle you have solved for this part.

(j) How much does Priscilla have to give to Madam Lim in Week 3 so that Madam Lim can afford her Week 1 bundle?

(k) Calculate Madam Lim’s utility maximising bundle in Week 3 had she been given the income you found in part (j). Calculate also the utility she achieves at this optimal consumption bundle. Is it higher, lower or the same as the utility you found in part (a)?

(l) How much does Priscilla have to give to Madam Lim in Week 3 so that Madam Lim can attain her Week 1 utility? Is this amount higher than, lower than or equal to the income you have found in part (j)? As you are calculating this amount, find also the consumption bundle Madam Lim will choose in Week 3 if she is given this income.

(m) On the same diagram you have drawn for part (i), draw the budget line associated with the part (l) budget. Label the consumption bundle you have found in part (l).

(n) What is the change in amount of Kopi from part (a) to part (i) (i.e., the change associated with a change in price but not money income)? What is the change in amount of Kopi from part (a) to part(l) (i.e., the change associated with a change in price but with a compensation in income to make up the same utility)? Which of the two changes is larger?

(o) Do your comparisons of the utility levels in parts (e) and (k) (i.e., whether Madam Lim is attaining a utility level higher than that in Week 1 when she is given an income to make her Week 1 bundle affordable) depend on whether it is a Kopi price increase or Kopi price decrease? Give an intuitive explanation.

(p) Madam Lim’s sister, Angela, has the following utility function

U(x, y) = min{x, y}.

The prices of Kopi (x) and Kuih (y) are $3 and $5, respectively. What is the minimum expenditure that allows Angela to attain the utility U = 10?

(q) Let E∗(Px, Py, U) be the solution to Angela’s expenditure minimisation problem. Write E∗(Px, Py, U) as a function of Px, Py, and U