Question 1.) Suppose that Steve and Jill, a married couple, have decided to allocate $250 per month to their "home decoration" budget which will be used to fund two types of decorations: i) the first involves antiques;ii) the modern items. Both Steve and Jillhave agreed to spend some money on each type of decoration. However, the two differ substantially in their preferences. Jill doesn't much care for the old dusty antique items, butshe thoroughly enjoys the look of modern decor. Steve loves the unique and classic looks of antique items, but he finds it difficult to relate to modern-styled decorations.
a) Draw an indifference map representing Steve's preferences (place "antiques" on the X-axis and "modern decor" on the Y-axis). On a separate graph, draw an indifference map representing Jill's preferences. (Hint: the slopes will be different. The curves need not be precise; they are illustrative of the two individuals' relative preferences.)
b) Using the concept of marginal rate of substitution (MRS), explain why the two sets of indifference curves look different from each other.
Question 2.) The following figure shows the indifference curve for Ruth's consumption of pears and peaches for a given level of utility.
a.) Compute the marginal rate of substitution moving from Point-A to Point-B. Show your work.
b.) Compute the marginal rate of substitution moving from Point-B to Point-C. Show your work.
c.) What pattern is observed in the MRS as you move down and to the right along the indifference curve? Using the concept of Diminishing Marginal Utility, explain why we should observe such a relationship.
Question 3.) Use the information and the graph below to answer all sub-parts to this question:
Assume:
Price of Cappuccino (P_C) = $4.00
Price of Gasoline (P_G) = $3.00
Mindy's income (I) = $100
a.) Write out the equation for the budget line as a function of Q_C, such that Q_C = .... Identify the value of the Y-intercept and the slope.
b.) Determine Mindy's marginal rate of substitution (MRS) at Point-B. Explain how you know this.
c.) Suppose Mindy told you that she is currently consuming at either Point-A, Point-B, or Point-C (but she do not tell you which one). She also informs you that at her current consumption bundle her marginal utility of gasoline is 16 while her marginal utility of cappuccino is 24. Given this information, at which point can you conclude she is currently consuming? In order to maximize her utility, explain (using your calculations) how Mindy should change her consumption bundle (Hint: I am looking for the qualitative conclusion here-should she increase/decrease her consumption of gasoline and increase/decrease her consumption of cappuccinos?).
Question 4.)
a.) Define, in your own words (do NOT copy definition from text), what it means for an allocation to be Pareto Efficient.
b.) Using the figure above, determine which of the labeled points are Pareto Efficient. Be sure to explain why you claim each point is or is not Pareto Efficient.
c.) Define the term Pareto Improvement (strong version). Does a Pareto Improvement necessarily lead to Pareto Efficiency? Why or why not?
d.) Starting from the initial allocation of resources at Point-A, determine whether a movement from Point-A to each of the other four labeled points is a Pareto Improvement (strong version). Be sure to explain.