MidtermS06Solutions

# MidtermS06Solutions - Econ. 130 Midterm Exam May 9, 2006...

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1 Econ. 130 Midterm Exam May 9, 2006 This is Exam A. Please write an A on the cover of your blue book. Part I. True-False (40 points) Please state whether the following statements are true or false. Provide a brief explanation (one paragraph at the most). Include graphs as necessary. Make sure to label any and all graphs. Exam A B C 1 3 8 All food stamp recipients always are better off receiving cash rather than the food stamps. False . Recipients that consume all the food stamps plus some additional food would be indifferent between cash and the food stamps; e.g., one with the indifference curve U0. Both cash and the food stamp put the consumer on U 0 . This consumer ends up at point A in figure 1. Others – like those at point B – would prefer cash because cash would move them to a higher indifference curve (U 1 instead of U 2 ). 2 4 7 Welfare payments tend to reduce the amount of labor supplied by welfare recipients. True . Recipients maximize welfare by choosing between leisure and other goods and services. Welfare payments tend to reduce the amount of labor provided. With a benefit reduction rate of 100 percent, labor force participation of recipients is zero, as shown in figure 2. The grant is P dollars. In this case, beneficiaries maximize utility, moving from an initial level of utility to of U 1 to one of U 2 , by leaving the work force. They end up at point A. 3 2 6 Pareto optimality requires that the marginal rate of substitution of one good for another is equal across all consumers in the economy. True . One of the conditions of Pareto optimality (or Pareto efficiency) is that the marginal rate of substitution of one good for another be equal across all consumers. If MRS is not equal across consumers, a deal can be made to make someone better off without making someone else worse off. E.g., in the Edgeworth box shown in figure 3, MRS is not equal at point A. A change in consumption that moves us to point B increases the welfare of consumer 1 without making consumer 2 worse off.

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2 Exam A B C 4 1 3 The US Social Security system unambiguously reduces national savings. False . The wealth substitution effect of Social Security tends to reduce national savings. But the bequest effect (i.e., the impact on the size of inheritances) and the retirement effect (its impact on retirement decisions) tends to increase national savings. Therefore, the impact is theoretically ambiguous – savings can increase or decrease. Empirical evidence also is mixed. 5 7 2 The maximin criterion implies that the income distribution should be perfectly equal, except to the extent that the utility of the worst off person can be improved by a departure from equality.
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## This note was uploaded on 10/27/2009 for the course ECON 183 taught by Professor Boustan during the Summer '09 term at UCLA.

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MidtermS06Solutions - Econ. 130 Midterm Exam May 9, 2006...

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