Question

Determine whether or not the following statements are true or false.

A.Imagine an indifference curve graph with units of clothing on the y-axis and visits to the neighborhood pizza joint for dinner on the x-axis. If the indifference curves for this individual slope downward but are close to horizontal, it means the marginal utility from another pizza dinner is quite low relative to the marginal utility of clothing.

B. A decrease in the price of good X and an equal percentage decrease in the price of good Y (ceteris paribus) shifts the budget line outward in a parallel fashion.

C. Joe consumes crawfish and shrimp and likes both. His utility function exhibits diminishing marginal utility of crawfish, but the marginal utility of shrimp is constant. Joe's indifference curves will slope downward at a decreasing rate.

D. Diminishing marginal utility violates the assumption that more is better.

E. Consider the utility function U(X,Y) = X^1/2 + 2Y. The consumer needs to be compensated with increasing amounts of good Y in order to be willing to give up each additional unit of good X.

Answer 1

(A)

Absolute Slope of indifference curve is given by MUx/MUy

Since the IC are nearly horizontal, the slope is nearly 0. So, MUx/MUy is nearly 0. Thus the given statement is true.

(B)

The given statement is true.

Absolute slope of budget line is given by Px/Py

Let us assume Px/Py = 10/20 = 1/2

And the price of x decrease by 50% and the price of y decrease by 50%.

The new Px/Py will be 5/10 = 1/2.

Thus the budget line shifts parallel.

Also, since the prices have decreased, the consumer will now be able to but more units of both the goods and thus there will be an outward parallel shift of the budget line.

(C)

Joe has quasi-linear utility function. His utility will be diminishing in crawfish and Constant in shrimp. His indifference curve will still slope downward.

If crawfish is plotted on the y axis and shrimp is plottedponpthe x axis, then Joe's indifference curve will slope downward at a decreasing rate. Hence, the statement will be true.

However, if shrimp is plotted on the y axis and crawfish on the x axis, then the statement will be false.

(D) Diminishing marginal utility means that the utility of consuming anaextra unit of a good decreases as more and more units of the good is consumed. The assumption more is better is not violated until the marginal utility is positive. This is because even though the marginal utility is decreasing, the total utility increases (but at a decreasing rate). However, as the marginal utility becomes negative, on consuming additional unit, the total utility derived from it decreases and the assumption that more is better is violated.

So the given statement is true.