Problem Set 1

Question 1

What does an indifference curve represent?

Answer 1

Represents all the possible combinations that are indifferent to one another and give the same utility.

Question 2

When drawing a budget set, what are the Y and X intercepts equal to?

Answer 2

• Y intercept = M/ Py

- X intercept = M/ Px

Question 3

Explain why LNS is important

Answer 3

LNS states that there will always exist a bundle in every e radius that is preferred to bundle X. By taking e to be sufficiently small we can ensure that this lies within the budget line as the difference is so small. If LNS doesn’t exist then consumers will consumer at bundle X which is within the budget set. We need LNS to hold so consumers can spend all their money to get as close as possible to this point.

Question 4

What happens at the point of utility maximization

Answer 4

The slope of the IC = Slope of the budget line

The slope of the IC = MRSy/MRSx, Slope of the budget line P1/P2

Question 5

If we have a utility function U(X1, X2)= Min {aX1.X2}, what type of good is this, and what is the kink equal to?

Answer 5

This is a perfect compliment L shaped, and the kink is at aX1=X2