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2003MidtermSolutions

# 2003MidtermSolutions - Solution to Midterm Exam Fall 2003...

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Solution to Midterm Exam Fall 2003 Economics 2020a / API 111 / HBS 4010 QUESTION 1 1. Use e ( p, v ( p, w )) w e ( p, u ) = r 16 p 1 p 2 u 3 w = r 16 p 1 p 2 v ( p, w ) 3 w 2 = 16 p 1 p 2 v ( p, w ) 3 v ( p, w ) = 3 w 2 16 p 1 p 2 . And Roy’s identity ... x 1 ( p, w ) = v p i v w = 3 w 2 16 p 2 1 p 2 6 w 16 p 1 p 2 = w 2 p 1 . QUESTION 2 2a) EV = e ¡ p 0 , u 1 ¢ e ¡ p 0 , u 0 ¢ is more appropriate than CV = e ¡ p 1 , u 1 ¢ e ¡ p 1 , u 0 ¢ since it uses the same base prices to compare the impact of the two policies. If we were to compute CV for the two policies, CV for the apple tax would use di ff erent reference prices than CV for the banana tax. Because of this, it is not necessarily the case that the policy with the smaller | CV | is better for the consumer (even if tax revenue is the same). 2b) For apples, there is no wealth e ff ect, and so EV is the same as CS (i.e., Marshallian and Hicksian demand curves coincide). A 10% increase in the price of apples raises it from 1 to 1 . 1 . This causes demand to decrease (using a linear approximation) to 50 100 ( . 1) = 40 . Therefore, (a linear approximation to) EV

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2003MidtermSolutions - Solution to Midterm Exam Fall 2003...

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