Name:

Microeconomic Theory
ECON 201, Spring 2025
Exam #1

Instructions
This exam is designed to test your knowledge of the material we have covered thus far. It consists
of 10 definitions and 4 analytical/short-answer problems. The exam is worth 100 points with the
following breakdown:

Definitions: 20 points, 2 points each;

Analytical/short-answer problems: 80 points, 20 points each, 5 points per part.

You must answer every part of the questions in order for your answers to be considered for full
credit, and you must also label all necessary items in any diagrams.
The exam is open book and open notes. However, copying from one another and/or cheating of
any kind will not be tolerated and will result in a zero on the exam.

Score:

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Definitions
In your own words define the following terms in one (maximum two) sentence(s). Each definition
is worth 2 points.

1. Budget set (or choice set):

All the option of goods that customer can

afford within their budget

2. Consumption bundle:
A collection of differnet goods that one will
consume or buy

3. Completeness (i.e. the assumption that preferences are complete):

If there are more than 1 goods, the customer
could always compare and make their buying
decision clear, whether they like it or not. No
uncertainty.

4. Convexity:
You would prefer a mix of 2 goods, rather than just a
lot of 1 good. Assume that you like them both the
same.

5. Indifference curve:
Showing different bundle of goods where a customer
has the same value of satisfication.

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 6. Marginal rate of substitution:
The rate at which someone is willing to trade one good for another, keep
the same level of happines (utility)

7. Utility function:
A function, a formular to calculate the satisfaction level of each bundles.

8. Marginal utility:

The extra satisfaction you get from consuming a prefered goods.

Ex: You like rice more than noodle, so consume 1 rice
bette(more satisfy) than 1 noodle.

9. Diminishing marginal utility:

The decrease in satisfication when you comsume too much of a good.

Ex: First bowl of rice is great, but a fifth one is like a torture.

10. Demand function:

A calculation of how much of a good people would buy based on their income,
price, etc.

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Analytical/Short-Answer Questions
Answer all parts of the following questions. Be sure to answer all parts of the questions in order for
your answer to be eligible for full credit. Each question is worth 20 points, with each part worth 5
points.

1. Suppose that a consumer chooses a bundle of two goods, respectively denoted as good 1 and
good 2. The consumer has income m to spend on the two goods, and faces prices p1 and p2 for
goods 1 and 2, respectively:

(a) Write down an equation for the consumer’s budget constraint.

m = p1x1 + p2x2

(b) Using your answer for part 1a, diagram the consumer’s budget constraint and identify their
choice set.

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(c) Redraw your diagram from part 1a and show what happens to the consumer’s budget
constraint and choice set if the price of good 2 increases such that p02 > p2 . What has
happened to the overall purchasing power of the consumer’s income m?

(d) Suppose that the price of good 1 increases by 50% if the consumer purchases more than
four units of the good. Diagram the budget constraint for this scenario.

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2. Use the concepts of perfect substitutes and perfect complements (including the utility functions
below) to answer the following questions:

Perfect substitutes: u(x1 , x2 ) = ax1 + bx2

Perfect complements: u(x1 , x2 ) = min {x1 , x2 }

(a) Diagram indifference curves for perfect substitutes. Assuming a = b in the utility function
above, and good 1 is cheaper than good 2, i.e. p1 < p2 , add a budget constraint to your
diagram and illustrate the consumer’s optimal choice.

(b) Draw another diagram for perfect substitutes and show the consumer’s optimal choice when
good 2 is the cheaper good (p2 < p1 ).

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(c) Diagram indifference curves for perfect complements. Add a budget constraint to your
diagram and illustrate the consumer’s optimal choice.

(d) Referencing the utility function for perfect complements above, draw a new diagram for
perfect complements and show what happens to the consumer’s optimal choice if the price
of good 1 decreases (p01 < p1 ).

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3. Use the Cobb-Douglas utility function below to answer the questions that follow:

u(x1 , x2 ) = xa1 x1−a

2

(a) Diagram and briefly explain how Cobb-Douglas preferences satisfy the convexity assump-
tion.

(b) Briefly explain how Cobb-Douglas preferences do not violate transitivity.

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(c) Diagram the indifference curves for Cobb-Douglas preferences. Add a budget constraint to
your diagram and illustrate the consumer’s optimal choice.

(d) Suppose the marginal utilities of the two goods from the utility function above are given
as: M U1 = axa−1
1 x2
1−a
and M U2 = (1 − a)xa1 x−a
2 . Write down an equation (or condition)
that characterizes the point for the consumer’s optimal choice in your answer to part 3c.
In one to two sentences explain the significance of this condition. (Hint: think about the
relationship between the budget constraint and indifference curve at the consumer’s optimal
choice.)

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4. Use the Cobb-Douglas utility function below to answer the questions that follow:

u(x1 , x2 ) = xa1 x1−a

2

(a) Diagram the indifference curves for Cobb-Douglas preferences. Add a budget constraint to
your diagram and illustrate the consumer’s optimal choice. Then suppose that the price of
good 2 decreases, p02 < p2 . Add this change to your diagram and identify the consumer’s
new optimal choice.

(b) Diagram the indifference curves for Cobb-Douglas preferences. Add a budget constraint to
your diagram and illustrate the consumer’s optimal choice. Then suppose that the price of
good 1 increases, p01 > p1 . Add this change to your diagram and identify the consumer’s
new optimal choice.

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(c) Diagram the indifference curves for Cobb-Douglas preferences. Add a budget constraint
to your diagram and illustrate the consumer’s optimal choice. Then suppose that the
consumer’s income increases, m0 > m. Add this change to your diagram and identify the
consumer’s new optimal choice.

(d) When we find the consumer’s optimal choice and derive their demand functions x∗1 (p1 , p2 , m)
and x∗2 (p1 , p2 , m), what do these demand functions tell us? Explain in one to two sentences.

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