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Case 1 for Instructiecollege 1 Economics 1.2, Bedrijfskunde. Micro Economics:Consumer behaviour.
Part 1. (Presented during class)
In this case we will solve the choice problem of a consumer, Herman, who has a monthly
budget of 160 euro that can be spent on two goods: Cheese and Wine. Currently, the price
of wine pw is 12 euro per liter, and the price of cheese pc is 4 euro per kg. We indicate the
amount of wine (liters) by qw and the amount of cheese (kg) by qc.
A. Make a graph of the combinations of cheese and wine that Herman can buy with
this budget. Put the amount of wine on the vertical axis.
B. How can we interpret the slope of the budget line?
C. The preferences of Herman are given by the following utility function:
U (qc , qw ) qc1/ 4 qw
Which of the following two consumption bundles does Herman prefer? (a). 16 kg
of cheese and 1 liter of wine, or (b). 2 kg of cheese and 3 liters of wine? Explain
your answer.
D. Do Herman’s preferences satisfy the properties of (i) completeness, and (ii) non-
satiation? Explain your answers.
E. Make a graph of the indifference curves for the following three utility levels: U =
8, U = 10, and U = 12. Put wine on the vertical axis.
F. Use your graph to determine Herman’s utility maximizing monthly consumption
bundle of cheese and wine, given the monthly budget of 160 euro, and the prices
pw = 12 and pc = 4. Clearly explain how you can deduct from the graph that this is
the utility maximizing bundle.
G. Determine Herman’s marginal rate of substitution (MRS).
H. Now use a computation to determine Herman’s optimal consumption bundle of
cheese and wine.
I. Suppose that Herman’s budget increases from 160 euro to 192 euro. What
happens to his budget constraint? Make a graph.
J. Compute Herman’s utility maximizing consumption bundle at the prices pw = 12
and pc = 4 and the new budget of 192 euro. Is cheese a normal or an inferior
good? And what about wine?
K. Now consider an increase in the price of wine: the price of wine has increased to
pw = 40 euro per liter. Draw the budget constraint if Herman’s budget is 160 euro
and the price of cheese is pc = 4 euro. Explain why the shape of the budget line
changes this way, compared to the line in question 2.
L. Determine the optimal consumption bundle of Herman at a budget of 160, and the
prices pw = 40 and pc = 4.
M. Are cheese and wine substitutes or complements to Herman? Explain your
answer.
N. Make a graph in which you decompose the total effect of the price increase of
wine into a substitution and an income effect. What is the size of the income and
the substitution effect for each of the two goods? (Indicate in the graph and
OPTIONAL compute).
1
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