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Cobb Douglas Utility Function Questions

This document contains an intermediate microeconomics assignment submitted by 3 students addressing questions related to a Cobb-Douglas utility function including calculating marginal utilities, deriving demand curves and income offer curves, explaining the Slutsky equation, and providing a graphical analysis of indifference curves and budget constraints. The assignment analyzes consumer choice theory concepts like marginal rates of substitution and the decomposition of price effects into substitution and income effects.

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huda.rauf781
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114 views

Cobb Douglas Utility Function Questions

This document contains an intermediate microeconomics assignment submitted by 3 students addressing questions related to a Cobb-Douglas utility function including calculating marginal utilities, deriving demand curves and income offer curves, explaining the Slutsky equation, and providing a graphical analysis of indifference curves and budget constraints. The assignment analyzes consumer choice theory concepts like marginal rates of substitution and the decomposition of price effects into substitution and income effects.

Uploaded by

huda.rauf781
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Intermediate Microeconomics Assignment

SUBMITTED BY: SUBMITTED TO:

Alina Noor (427522) Ma’am Ayesha Javed

Noor ul Huda Rauf (408582)

Shehrbano Hussain (407910)

BS ECONOMICS 22
Section B
Economics Questions: Cobb-Douglas Utility Function

1. Marginal Utility: Calculate the marginal utility of good x and good y for the utility
0.5 0.5
function U(x, y) = 𝑥 𝑦 . How does the marginal utility change as the
consumption of either good increases?

Answer:

Marginal Utility of a commodity is the rate of change of total utility, as the quantity of the
commodity consumed changes.

Marginal Utility of good x: MUx = ∂U/∂x = 0.5x-0.5y0.5

As the consumption of good x increases, the marginal utility of good x decreases.

Marginal Utility of good y: MUy = ∂U/∂y = 0.5x0.5y-0.5

As the consumption of good y increases, the marginal utility of good y decreases.

2. Marginal Rate of Substitution (MRS): Derive the formula for the MRS for this
utility function. Calculate the MRS when x = 10 and y = 10. What does this tell you
about the consumer's willingness to trade one good for the other?

Answer:

Marginal Rate of Substitution refers to the rate at which a consumer can give up an
amount of one good for another good, all the while maintaining the same amount of
utility or satisfaction. It is the ratio of the MU of one good to the MU of another.

MRS= MUx/MUy

Derivation of Marginal Rate of Substitution:

∂U/∂X (dx) + ∂U/∂Y (dy) = 0

∂𝑈 ∂𝑈
∂𝑌
(dy) = - ∂𝑋 (dx)

−∂𝑈/∂𝑥
dy/dx = ∂𝑈/∂𝑌
𝑦
MRS= - 𝑥

Substitute the previously calculated values in this formula:

0.5 • 𝑥−0.5 • 𝑦0.5


MRS= − 0.5 • 𝑥0.5 • 𝑦−0.5

𝑦0.5
MRS= – 𝑥0.5

𝑦
MRS= − 𝑥

y=10 x=10

10
MRS𝑥𝑦 = − 10

MRS𝑥𝑦 = -1

This MRS suggests that the consumer is indifferent between the two goods. The
consumer remains equally satisfied when exchanging one good for another. Both goods
are valued equally.

3. Ordinary Demand and Price Offer Curves: Assuming the prices of x and y are Px
and Py respectively, and the consumer's income is I, derive the demand functions
for x and y. Consider Px = 1, Py = 2, and I = 20. How do the demand curves for x
and y change as Px varies while Py and I remain constant?

Answer:
4. Income Offer Curves and Engel Curves: Derive the income offer curve for this
utility function. Plot the Engel curve for good x assuming Px and Py are constant.
How does the quantity of x demanded change with varying income levels?

Answer:

If p(X) increases the consumer will consume less of it. consumers tend to demand less
of a good when their prices increase. The demand of Y good can increase in this case.

If p(X) decreases the consumer will get more of a good x. The demand for good x
increases. The demand for products with lower price increases.

5. Slutsky Equation: Explain the Slutsky equation in the context of this utility
function. Graphically illustrate the substitution and income effects for a price
change in good x. How do these effects contribute to the overall change in
quantity demanded?

Answer:

The Slutsky equation is an economic concept named after Eugen Slutsky. It is a


fundamental result in consumer theory and helps analyze the effects of price changes on
the quantity demanded of a good. The Slutsky equation decomposes the total effect of a
price change into two components: the substitution effect and the income effect.

In this utility function we have U (x,y) = x 0.5 y 0.5 where x and y are the quantities of the 2
goods with their respective prices at px and py. The budget constraint will be
Px.X + Py.Y = I (where I = income)

Considering the change in the price of good x,we assume that the price of x decreases
from Px to Px’

Substitution Effect:

Slutsky assumed that at new prices, the consumer can just only buy the original bundle
so that the effect of only the change in relative prices on demand can be observed.
Lower prices of good x will cause the budget constraint to pivot outwards along the x
axis as people will now be able to afford more of good x at the given income. As good x
becomes cheaper, consumers substitute it for now relatively more expensive other
commodities i.e. y. Demand of x increases from x’ to x” and y decreases from y’ to y”

Income Effect:

Due to lowered prices of x, the consumer's budget of $I can purchase more than before
as if the consumer's income rose with consequent income effects on quantities
demanded.

For graphical analysis, we assume that the price of good x decreases. (x’,y’) to (x”,y”)
shows the pure substitution effect while (x”,y”) to (x”’,y”’) shows income effect. The
change in demand due to lowered prices is a sum of both these effects i.e. (x’,y’) to
(x”’,y”’). The overall quantity demanded for good x increases and for good y decreases.
6. Graphical Analysis: Draw the indifference curve for the utility level U = 10. On
the same graph, illustrate the budget constraint given Px = 1, Py = 2, and I = 20.
Identify the optimal consumption bundle.

Answer:

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