SAMPLE_PRELIM_1_SOL - PAM 2000 Suggested Solutions to...

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1 PAM 2000 Suggested Solutions to Sample Questions for Prelim I. I. True, False or Uncertain. Explain. 1) It is possible for Sue to be maximizing utility at a particular choice of bananas and pears, but for the marginal rate of substitution between bananas and pears to exceed the ratio of prices at those choices. False, assuming that we do not have any corner solutions (see page 93). For Sue to be maximizing utility, the MRS must be equal to the ratio of prices. Algebraically, when maximizing utility, we have P B P B P P MU MU = . The question asks, can we have utility maximization when: P B P B P P MU MU > . That is not possible, because Sue could then increase the amount of bananas she is consuming, and decrease the number of pears, and she would be better off (i.e. before she was not maximizing utility). As she did so, the MU of bananas would fall, and MU of pears would rise, due to the principle of diminishing marginal utility, until P B P B P P MU MU = were true. The same thing can be shown using the equi-marginal principle.
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