Spring 2007 - Famulari's Class - Exam 2

Spring 2007 - Famulari's Class - Exam 2 - Econ 100A:...

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Econ 100A: Microeconomics, Spring 2007, Dr. Famulari Midterm 2A: 250 Points 1A. (10 points) A consumer derives utility from the consumption of X and Y. Using budget lines and indifference curves, illustrate the effect of an INCREASE in the price of X on the consumer’s utility maximizing choices of X and Y. Y | | | | | | Y 1 * | B Y 1 C | A’ | A Y 0 * | | U 1 U 0 | |______________________________________ X 0 * X 1 C X 0 * I/Px 0 X 1B. (30 points) Illustrate on your graph above and explain carefully in words what are the income and substitution effects of the increase in the price X. Substitution effect: With the increase in the price of X, X is relatively more expensive than Y. Even if we kept the consumer at the same level of utility (U 0 ), the consumer would substitute away from the consumption of X and towards the consumption of Y. This is the movement from A to A’ in the graph above. Income Effect: With the increase in the price of X, the consumer’s budget set has contracted. This decrease in the consumer’s income can be measured as the movement from A’ to B in the graph above 1C. (20 points) What is the definition of a normal good? Is Y in your graph above a normal good? CAREFULLY explain how your graph illustrates whether or not Y is a normal good. Definition of a Normal good: I I p p X y x ) , ( , * >0 The movement from A’ to B is the income effect. Since Y 1 * >Y 1 C , Y is a normal good (based on the graph I drew).
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Question 2 (40 points total) Toni gets utility from X and Y. Toni only likes to consume 3X with 4Y: more X without getting more Y is of no use to Toni as is more Y without getting more X. Suppose the price of X is $30 and the price of Y is $10. Toni minimizes her expenditures
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Spring 2007 - Famulari's Class - Exam 2 - Econ 100A:...

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