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Econ501amidans02

# Econ501amidans02 - The Ohio State University Department of...

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Department of Economics Econ 501a Winter 2002 Prof. James Peck Midterm Questions and Answers Part I: Short Answer. 1. (10 points) True or false, and explain: Suppose that good x is a normal good. If a consumer’s income increases, then that will cause a movement to a new point on her ordinary demand curve, with a lower p x and a higher quantity of x . Answer: False. It was speci…ed that income changed, not p x . Rather than moving to a new point on her ordinary demand curve, the increase in income will shift the demand curve. There will be a horizontal movement from one ordinary demand curve (corresponding to the original income) to another ordi- nary demand curve (corresponding to the higher income), keeping p x constant. Because the good is normal, the demand curve will shift to the right. 2. (10 points) True or false, and explain: Consider an Edgeworth Box economy with an initial allocation for the two consumers given by ( x 1 ; y 1 ; x 2 ; y 2 ) . The initial allocation is represented by the point plotted in the Edgeworth Box, below. If there is another feasible allocation that both consumers prefer to the initial allocation, then that allocation is not necessarily Pareto optimal. Answer: True. Just because the consumers can …nd a new allocation to make themselves better o¤, it does not mean that there cannot be further gains from a second trade. In the diagram below, suppose that the initial allocation is where the two indi¤erence curves intersect (near the southeast corner of the box). The utility functions underlying this example are tangent along the 45 degree line, so any Pareto optimal allocation must be on the diagonal of the box (the segment connecting (0,0) and (1,1)). It is easy to see that the point plotted as a circle makes both consumers better o¤ than their initial endowments, but it is not Pareto optimal. 1

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Econ501amidans02 - The Ohio State University Department of...

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