MS10 - Economics 104A Solution for Midterm Exam Winter 2010...

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Unformatted text preview: Economics 104A Solution for Midterm Exam Winter 2010 1. (8pt) Assume that John would like to purchase 50 gallons of gasoline at price of $1.50 per gallon. However, the $1.50 is the result of a government price ceiling, so there is a shortage, and John can get at most 25 gallons. Draw John’s budget line with gasoline (good G), consumption on all other goods (good C), p G = 1 . 5, and p C = 1. Use the budget line and ICs to show that John will be willing to pay a price higher than $1.50 to get additional units of gasoline. Be precise and label your diagram completely. Answer: Since the optimal quantity of gasoline at prices p G = 1 . 5 and p C = 1 is 50 gallons, we have MRS = p G p C = 1 . 5 at quantity 50 gallons of gasoline. It follows that MRS > p G p C > 1 . 5 at quantity 25 gallons. Since MRS represents John’s valuation of an additional gallon in terms of consumption of all other goods, it follows from the preceding inequality that John is willing to pay more than $1.50. See Figure 1 for aninequality that John is willing to pay more than $1....
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MS10 - Economics 104A Solution for Midterm Exam Winter 2010...

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