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Midterm 2 solutions - 73 150 Microeconomics(Fall 2008...

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73 – 150 Microeconomics (Fall 2008) Solutions for Midterm 2 1. Giffen good: acceptable answers - A strongly inferior good, whose quantity demanded increases as price increases - An inferior good for which the income effect outweighs the substitution effect Income effect: - the component of a price change that is associated with real purchasing power - ex. for a normal good, an increase in price decreases purchasing power hence decreases the quantity purchased (attributable to the income effect) 2. See the printout of the Carter example about the decrease in demand for gas To receive full credit the student must include the 3 equations of the budget lines as well as the graph depicting the budget lines and properly placed indifference curves and optimal bundles showing a decrease in the quantity of gas demanded. - 3 points B 1 (pre-tax): p x x + p y y = I - 3 points B 2 (after-tax) (p x + t)*x + p y y = I - 3 points B 3 (after grant) (p x + t)*x + p y y = I + tx The optimal bundle after tax is the point where B 1 and B 3 intersect. Using labeled bundles and/or indifference curves, the student must show that the quantity of gas at this bundle is less than the quantity of gas demanded at the original bundle (which also must be labeled),
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