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Px & QUESTIONS Assignment Instructions
Prepare your assignment in accordance with the following instructions:
1. Answer all questions.
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There are a total of twenty (20) marks available on this assignment. This assignment
contributes 25% of your final grade.
Suppose that Sally’s preferences over baskets containing coffee (good x), and milk (good
?
y ), are described by the utility function U(x, y ) = 40 x +y . Sally’s corresponding marginal
utilities are, 20
MUx = ?
x and MUy = 1. The price of coffee is Px = $4 per cup, and the price of milk is Py = $1 per litre. Sally’s
income is I = $200.
Question 1: Without deriving the optimal consumption basket, show that the basket with
x = 25 cups of coffee, and y = 50 litres of milk, is NOT optimal. (3 Marks)
Question 2: Derive the expression for Sally’s marginal rate of substitution. (1 Mark)
Question 3: Find Sally’s optimal consumption basket. (3 Marks)
Question 4: Find Sally’s new optimal consumption basket if the price of coffee increases
to Px = $5 per cup. (3 Marks)
Question 5: Is coffee a Giffen good for Sally? Briefly explain. Your answer must reference
the consumption baskets you found in questions 3 and 4. (3 Marks)
Question 6: Find the income and substitution effects associated with an increase in the
price of coffee from $4 to $5 a cup. (4 Marks)
Question 7: Describe the relationship between Sally’s demand for coffee and her income.
Your answers must reference the your previous answers, AND use the correct term to
describe the relationship. (3 Marks) 2
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