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
=24549=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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 Winter '08
 Buddin
 Microeconomics, ice cream, Rachel

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