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Unformatted text preview: The Ohio State University Department of Economics Econ 501a Prof. James Peck Midterm Exam Questions and Answers Part I: Short Answer. 1. (10 points) Suppose that there are two goods, x and y, and that x is an inferior good. Show as precisely as you can why good y must be a normal good. Answer: Since prices remain constant, when there is more income and less of good x being purchased, the amount of money left over to purchase good y is higher. Therefore, more of good y is demanded as income increases, so y is a normal good. From the budget equation, p x x + p y y = M; we see that if M goes up and x goes down, y must go up. Another way to see this is to di¤erentiate the budget equation with respect to M, p x @x @M + p y @y @M = 1 : Since the …rst term is negative, the second term must be positive, so y is a normal good, @y @M > : 1 2. (10 points) True or false, and explain: The income e¤ect on the demand for gasoline, when the price of gasoline increases from $1.50 to $1.60, is likely to be greater for someone who drives a lot than for someone who does not drive very much. (Give a verbal explanation. You do not have to graph this.) Answer: This statement is TRUE. The income e¤ect is based on the fact that a price increase lowers your overall purchasing power and puts you on a lower indi¤erence curve. Other things equal, the person who consumes more gasoline will feel that his purchasing power has fallen by more than the person who does not consume very much gasoline. In the extreme case of someone who does not drive at all, the income e¤ect would be zero. Income e¤ects tend to be small for most goods, those that constitute a small fraction of our consumption spending. 2 3. (10 points) In the Edgeworth Box diagram, below, …nd an initial endowment point for which ( x ¤ ;y ¤ ) is an equilibrium allocation. Clearly label the initial endowment point you are choosing, and brie‡y explain why ( x ¤ ;y ¤ ) is an equilibrium allocation for that endowment....
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 Spring '08
 YANG
 Economics, Microeconomics, Supply And Demand, demand function, total cost function

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