EC 203 PS: CH 9 FALL 2005

1. Sertaç has a small garden where he raises eggplant and tomatoes. He consumes some of these vegetables and sells some in the market. Eggplants and potatoes are perfect complements for Sertaç, since the only recipes he knows use them together in a 1:1 ratio.

One week his garden yielded 30 kg of eggplant and 10 kg of tomatoes. At that time the price of each vegetable was 5 YTL per kg.

a) What is the monetary value of Sertaç’s endowment of vegetables?

b) On a graph with tomatoes on the horizontal axis draw Sertaç’s budget line. Sertaç ends up consuming ___ kg of eggplants and ____ kg of tomatoes. Draw the indifference curve through the consumption bundle that Sertaç chooses and label this bundle A.

c) Suppose that before Sertaç makes any trades, the price of tomatoes rises to 15 YTL and the price of eggplant stays at 5 YTL. What is the value of Sertaç’s endowment now (____ YTL)? Draw his new budget line. He will now choose a consumption bundle consisting of ____ tomatoes and ____ eggplants. Label this bundle C. Show all the effects on the graph!

d) Suppose that Sertaç had sold his entire crop at the market for a total of 200 YTL, intending to buy back some tomatoes and eggplant for his own consumption. Before he had a chance to buy anything back, the price of tomatoes rose to 15 YTL while the price of eggplant stayed at 5 YTL. Draw his budget line. Sertaç will now consume ____ kg of tomatoes and ____ kg of eggplant. Label this bundle D. Show all the effects on the graph!

e) Assuming the price of tomatoes rose to 15 YTL from 5 YTL before Sertaç made any transactions, the change in demand for tomatoes due to the substitution effect was ____. The change in the demand for tomatoes due to the ordinary income effect was ____. The change in the demand for tomatoes due to the endowment income effect was _____. The total change in demand for tomatoes was ____. Show all the effects on the graph!

Compare this exercise with the one on page 171 of the textbook (Figure 9.7). Observe that the labels are the same. Why is there a difference regarding the substitution effect?

2. Cem has an endowment of 3 units of good x and 5 units of good y. He can buy and sell x at a price of $100 and y at a price of $200. He receives an income of $700 as alimony from a former spouse.
a. Draw Cem's budget line for x and y. Show his initial endowment of x and y on your diagram.

b. Calculate the amount of x that he could afford if he bought only x and the amount of y he could afford if he bought only y.
c. Write an equation for Cem's budget.

b. He could afford 20 units of x and no y or 10 units of y and no x.
c. His budget is 100x + 200y = 2,000.

3. Aslı is a journalist. She is considering two possible jobs. One job is as an editor for a magazine. The other job is writing freelance articles and selling them to whoever will buy them. If she works for the magazine, she must spend 10 hours a day at work and commuting. She will be paid $130 a day net of commuting costs and taxes if she takes this job. If she writes freelance articles, she can work at home and as many hours a day as she pleases. She estimates that she would earn $10 an hour after taxes if she does this. Her utility function is U = R3C, where R is the number of hours a day she spends not working or commuting and C is her earnings.
a. If Aslı chooses to freelance, how many hours will she work?
b. Calculate her utility in each job and identify which job she will choose.

a. 6 hours.
b. If she freelances, U = 349,920. If she works for the magazine U = 356,720. She should choose the magazine.

4. Şesu has 18 hours per day to divide between labor and leisure. His utility function is U(C,R) = CR, where C is dollars per year spent on consumption and R is hours of leisure. If he has 5 dollars of nonlabor income per day and gets a wage rate of 11 dollars per hour when he works, his budget equation, expressing combinations of consumption and leisure that he can afford to have, can be written as

a. C = 203 + 11R.

b. R + C/11 = 269.

c. 11R + C = 5.

d. 11R + C = 203.

e. C = 218 + 11R. Answer: D

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