2023F Assignment 2 Ver1.1

Intermediate Microeconomics Assignment 2
ECON2210 Fall 2023
Due by noon Oct 14th
The credit attached to a question reflects neither its difficulty nor the amount of time
you are expected to spend. The straightforward questions with most credits are must-know.
Collaboration is highly encouraged. Please credit your classmates’ input in your submitted
work. You may submit one set of answers in a group of up to THREE students.
1. (5%) Suppose the prices of good 1 and good 2 are $5 and $2. Sandy has a budget of
$80. The graph below depicts the goods bundle D = (10, 12). Find out its horizontal
distance ∆x1 from the budget line.
Hint: What is the economic interpretation of ∆x1 ?
1
√
2. (15%) Consider U (x1 , x2 , x3 ) = ( x1 +x3 )x2 . The budget line is given by x1 +12x2 +
4x3 = 100.
The following bundles are NOT optimal. Explain how to adjust the quantities of
goods in the bundle to attain a higher utility level.
(a) (64, 3, 0)
(b) (16, 4, 9)
(c) (4, 4, 10)
3. (15%) Suppose the budget line is given by 2x1 + 5x2 = 100. The following utility
functions all represent well-behaved and strictly convex preferences. Solve out the
corresponding optimal bundle.
(a) U (x1 , x2 ) = x1 + x2 − exp(−2x1 )

(b) U (x1 , x2 ) = 1 − x401 − x12
x1 x2
(c) U (x1 , x2 ) =
40x2 + x1
4. (15%) Consider a setting with two goods. Good 1 is food and its price is $4. Good
2 is shelter and the rental rate is $6. Sally has income $3000. She also receives food
stamp which she may redeem for food up to the AMOUNT $300 at the market price.
Initially, Sally consumes 300 units of food (including those from food stamp) and
spends the rest of her income on shelter.
(a) Find out the initial quantity of shelter x̂2 Sally consumes.
Now suppose the price of food increases from $4 to $5.
(b) Let good 1 and good 2 be the horizontal and vertical axis respectively. Draw
the budget sets BEFORE and AFTER the increase in price in the same graph.
Hint: How much food is the food stamp redeemed for before and after the price
increase?
(c) Following the price increase, the government considers replacing the food stamp
program with an ad valorem food subsidy. In the new subsidy program, the
household will get q% of her food expenditure reimbursed. Find out the minimum
subsidy rate q under which Sally can still afford her initial bundle (300, x̂2 ).
2
5. (15%) This exercise demonstrates a systematic approach to draw a budget set. This
approach is useful for handling complicated policies or market imperfections.
Suppose good 1 and good 2 are sold by firm 1 and firm 2 respectively. Initially,
Betty’s budget line is given by 4x1 + 5x2 = 240. Now suppose firm 2 agrees to offer a
40% off on good 2 if a customer checks out with at least $100 spending on its goods.
For example, Betty pays firm 2 only $90 if she purchases $150 worth of good 2. Note
that the discount, if eligible, applies to all units bought.
(a) Write down Betty’s budget line if firm 2 always offers a 40% off on its goods
irrespective of the spending amount. Let good 1 and good 2 be the horizontal
axis and vertical axis respectively. Graph this budget line and the budget line
without the discount policy in the same graph.
(b) Draw the budget set under the new discount policy. Label the relevant points
clearly.
Hint: How does the budget set under the firm 2’s discount policy relate to the
budget lines with and without a 40% off discount?
(c) Is the bundle X̂ = (40, 16) affordable under the new discount policy? Label the
bundle X̂ in your graph of budget set.
(d) Suppose that you do not know Betty’s preference but assumes it is well-behaved.
Do you expect Betty to choose the bundle (40, 16)? Explain your answer.
3
6. (20%) Suppose Alice’s well-behaved preference can be represented by U (x1 , x2 ) =
x1 + x2 + x1 x2 , where good 1 is cigarettes and it is perfectly divisible.
(a) Initially, Alice is a smoker. Her budget line is given by 3x1 + 4x2 = 17. How
many cigarettes is Alice consuming?
(b) Now government imposes a unit tax t on cigarettes. For simplicity, assume the
price of cigarette remains unchanged. That is, Alice has to pay a unit tax t
in addition to the cigarette price p1 = 3 for every cigarette bought. She quits
smoking under the new policy.
i. Depict how Alice’s budget line and consumption bundle change.
ii. Find out the possible range for the unit tax t.
Hint: You should translate the previous graph into a mathematical condition.
iii. Bobby comments that “As long as the government imposes a unit tax t > 14,
a cigarette will cost more than 3+14 = 17 dollars. Alice can no longer afford
a cigarette with her entire budget. She has no choice but to quit smoking.”
Explain why Bobby is wrong.
4
7. (15%) Suppose there are only two goods. Good 1 is food and good 2 is accommodation.
Ramesh is living in Singapore and consuming the bundle X. e His employer plans to
transfer him to the Hong Kong office. However, the rental rate is much higher in
Hong Kong than in Singapore. Ramesh expresses his concern about the high housing
cost. After negotiation, the employer agrees adjusting his new salary to the level that
the current bundle X e is just affordable to Ramesh in Hong Kong. That is, his new
salary will exactly cover the cost of X
e in Hong Kong.
Let us assume Ramesh’s preference is well-behaved and strictly convex. Furthermore

the relative price of accommodation is higher in Hong Kong than in Singapore. The
following question asks you to translate the given information into a graph.
(a) Draw the following objects in the same graph

Ramesh’s current budget line in Singapore
Ramesh’s current optimal bundle X e
Indifference curve passing through X
e
Ramesh’s new budget line in Hong Kong if he relocates.
Make sure your answer is qualitatively consistent with provided information.

(b) Ramesh’s relocation decision can be modelled as a choice between two budget
sets. Explain whether Ramesh should agree to the relocation. Specifically, is he
better off with the relocation?
Hint: Make use of your previous answer. Where may Ramesh’ optimal bundle
in Hong Kong locate in your graph? His initial choice of bundle is informative
about his preference.

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Intermediate Microeconomics Assignment 2

ECON2210 Fall 2023

Due by noon Oct 14th

Hint: What is the economic interpretation of ∆x1 ?

(a) U (x1 , x2 ) = x1 + x2 − exp(−2x1 )

Now suppose the price of food increases from $4 to $5.

Let us assume Ramesh’s preference is well-behaved and strictly convex. Furthermore

(a) Draw the following objects in the same graph

Make sure your answer is qualitatively consistent with provided information.

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