Question

Eric consumes only cheese and bread. His income is £100. Cheese costs him £0.50 per can and bread cost £1 each. If p is the number of packs of cheese and q the number of loafs of bread he consumes per week, Eric's utility function is u(p, q) = −[(p − 50)² + (q − 40)²] . Which one of the following statements is correct?

a. Eric must always be unhappy since, whatever he consumes, his utility is always negative

b. Eric has monotonic preferences

c. If his income increases, Eric will not change the bundle he consumes

d. If the price of cheese goes down, Eric will buy more cheese

e. More than one of the above statements are correct

f. None of the above

Answer 1

Answer - C (If his income increases, Eric will not change the bundle he consume)

His utility is not always negative. When p= 50 and q =40, his utility is 0 (which is non negative)

The preference is not monotonic. U(51,41) < U(50,40). Also, U(49,39)< U(50,40)

With current income, Eric is maximizing his utility by buying 50 pack of cheese and 40 loafs of bread. Even if his income increase, he should not increase consumption as it would reduce his utility.