midterm2 answers 2008w

midterm2 answers 2008w - Answer Key Second Midterm: Econ...

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Answer Key Second Midterm: Econ 101 Richard Buddin Winter 2008 Please answer all questions. The questions are in no particular order. If you do not understand a question, you should skip it and return to it later in the exam. 1. Henry is a retired professor and has moved to a remote cabin in the mountains. He lives on a diet of nuts (N) and rabbits (R). His production function for gathering nuts is N=(3/2)(L N ) 0.5 and for hunting rabbits is R= L R 0.5 , where N is pounds of nuts per month, R is number of rabbits per month, L N is the number of hours spent gathering nuts per month, and L R is the number of hours spent hunting rabbits per month. His utility function is U=R 0.2 N 0.8 , and he works 245 hours per month. a) Find the formulas for Henry’s PPF, RPT, and MRS. b) What are the optimal consumption and production values of R and N if Henry does not trade? How many hours per month should he spend hunting rabbits and gathering nuts? c) Henry’s neighbor offers to give him a ride to the nearby town, where Henry is able to buy and sell nuts and rabbits at a farmer’s market. The price ratio of rabbits to nuts is $3. With these trade opportunities, what are Henry’s optimal consumption and production values for R and N? d) Henry’s neighbor is puzzled by Henry’s consumption patterns before and after trade. The neighbor argues that Henry is wealthier with trade, so he should consume more of both goods after trade than before trade. Discuss how you would expect consumption patterns to change with the introduction of trade in the context of this problem. Answer: a) PPF: R 2 +(4/9)N 2 =245. RPT=2.25(R/N). MRS=0.25(N/R) b) R*=7 and N*=21. He will produce & consume the same amounts. L R =49 & L N =245-49=196. c) Production: R=14 & N=10.5. Consumption: R=3.5 & N=42. d) Henry is wealthier with trade, but relative prices have changed as well. A pure wealth increase would increase purchases of both goods, if the goods were normal. In this case, the slope of the budget line shifts because relative prices have changed. N has gotten relatively much cheaper for Henry, so he disproportionately spends his extra wealth on N. Similarly, the opportunity cost of R has increased relative to N, and he consumes less R at his higher wealth. 2.
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midterm2 answers 2008w - Answer Key Second Midterm: Econ...

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