PS3_SOL - PAM 200, Intermediate Microeconomics Problem Set...

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1 PAM 200, Intermediate Microeconomics Problem Set 3 Return to TA by beginning of class Wednesday, October 4th I. True, False or Uncertain. Explain . No credit given without explanation. Use graphs to help explain your answer whenever possible (2 points each). Total: 8 points 1) If a consumer is compensated for the income effect that occurs when the price of a good increases, then his demand curves can never slope upward. Answer: True. The demand curve would only include the substitution effect. Even for Giffen goods, dq/dp is negative holding utility constant. 2) Suppose Sue consumes only two goods, bananas and pears. If the price of bananas rises, then the quantity of pears consumed will always fall (use the consumer equilibrium diagram to help explain your answer). Answer: False. Since the question assumes only 2 goods, and tells you to use the consumer equilibrium diagram, that diagram should be used: If the price of bananas rises, the quantity of pears consumed can either rise or fall. What does that depend upon? It depends on how the income and substitution effects embedded in the change in the price of bananas affects pears. If pears are a normal good, then the income and substitution effects will work in opposite directions for pears. The substitution effect of an increase in the price of bananas will always reduce the number of bananas and increase the number of pears consumed in a two-good world. The income
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This note was uploaded on 11/14/2009 for the course PAM 2000 taught by Professor Evans,t. during the Spring '07 term at Cornell University (Engineering School).

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PS3_SOL - PAM 200, Intermediate Microeconomics Problem Set...

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