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ECO101-PS5 - MIDDLE EAST TECHNICAL UNIVERSITY NORTHERN...

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MIDDLE EAST TECHNICAL UNIVERSITY – NORTHERN CYPRUS CAMPUS ECO 101 (01, 02, 03) FALL 2010 PROBLEM SET 5 Part A. Problems 1. Suppose that Omer lives in a world with only two goods, apples and bananas. Omer’s income each month is 50 TL. Apples cost 2 TL per unit, and bananas cost 5 TL per unit. a. Graph Omer’s budget constraint with apples on the vertical axis, and shade the area representing all the bundles of apples and bananas that Omer can afford. Express the budget line equation and calculate its slope. b. Suppose that the price of apple went up to 5 TL per unit while all the other things remained unchanged, what would happen to his budget constraint? Show graphically and algebraically. Comparing with the original budget constraint does the slope change or not? c. Suppose that Omer’s income doubles while prices remained unchanged from their original level. Show graphically and algebraically what happens to Omer’s budget constraint. Comparing with the original budget constraint does the slope change or not? d. Now suppose that Omer’s income doubles, but that prices also double. What would happen to his budget constraint? Comparing with the original budget constraint does the slope change or not? e. Suppose that prices of apple and banana doubles while Omer’s income remained unchanged from his original level. Draw Omer’s new budget line. 2. The following two tables illustrate Ezgi’s total utilities from spending on earrings (e) and bags (b). Suppose that Ezgi has a monthly budget of 36000 YTL, each earrings cost 6000 TL, and each bag costs 3000 TL. a. Fill in the figures for marginal utility and marginal utility per TL for both earrings and bags. Q(e) TU(e) MU(e) MU(e)/P(e) Q(b) TU(b) MU(b) MU(b)/P(b) 0 0 0 0 1 200 1 250 2 290 2 295 3 370 3 335 4 440 4 370 5 500 5 400 6 550 6 425 7 590 7 445 b. Are Ezgi’s preferences consistent with the “law of diminishing marginal utility”? Explain briefly. c. Given her budget of 36000 TL, what combination of earrings and bags will maximize Ezgi’s level of satisfaction.

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