PAM200 Prelim1 - PAM 200 Preliminary Exam #1 Spring 2008 -...

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PAM 200 – Preliminary Exam #1 – Spring 2008 - Solutions 1. The following table represents the possible combinations of on-line video games that can be played on your own, and the number of romantic walks that you can take with your girlfriend/boyfriend, in a weekend (For example, it is possible to play 4 Video Games and take 3 Romantic Walks, etc). What is the opportunity cost of playing 1 Video Game? 0.5 WALKS (5 points) Video Games Romantic Walks 0 5 2 4 4 3 6 2 8 1 10 0 2. Please explain why it is irrational for indifference curves to cross. You may use a diagram if this is helpful. (10 points) IT IS IRRATIONAL FOR INDIFFERENCE CURVES TO CROSS BECAUSE THIS WOULD INDICATE IN CERTAIN REGIONS THAT LESS IS PREFERRED TO MORE. 3. A person has $10 and can spend the money on only two goods: chocolate or milk. The price per unit of chocolate is $2 and the price per unit of milk is $5. a. On the following chart draw the budget constraint between chocolate and milk. Be sure to mark clearly both intercepts and the slope of the budget constraint. (5 points) THE BUDGET CONSTRAINT IS C=5-2.5M, AS SHOWN BY THE BLACK B.C. b. If the government now begins taxing both Chocolate and Milk at a rate of 20%, draw the new budget constraint, indicating clearly the two intercepts and the slope. (5 points) THE NEW BUDGET CONSTRAINT IS C=1.67-2.5M, AS SHOWN BY THE RED B.C. c. What happens to the opportunity cost of Milk as a result of the taxes? Please Explain. (5 points) NOTHING. THE PRICE OF EACH OF MILK AND CHOCOLATE INCREASE BY 20% SO THERE IS NO CHANGE IN THE RELATIVE PRICES AND NO CHANGE IN OPPORTUNITY COSTS (THE SLOPE OF THE B.C. IS UNCHANGED). d. Assume that initially, in the no-tax case, that the person spent half of their money on Chocolate and half on Milk. Mark the initial consumption point clearly. After the taxes are imposed mark the final consumption point on the after-tax budget constraint. Does the quantity of Milk increase or decrease. Please explain. (5 points) THE FINAL CONSUMPTION POINT IS ON THE RED BUDGET CONSTRAINT, BUT IT IS NOT POSSIBLE TO KNOW WHETHER IT IS TO THE RIGHT OF THE INITIAL CONSUMPTIONS BUNDLE SINCE WE DO NOT KNOW WHETHER CHOCOLATE AND MILK ARE NORMAL OR INFERIOR.
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PAM200 Prelim1 - PAM 200 Preliminary Exam #1 Spring 2008 -...

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