Unformatted text preview: Econ 326 midterm #1 Name___________________________________
Spring 2011 Student ID_________________________________ TA name _________________________________
Part 1: Multiple choice, 4 points per question. Choose the one alternative that best completes the statement or answers
the question. Please mark your answers on the scantron.
1) A consumer prefers market basket A to market basket B, and prefers market basket B to market
basket C. Therefore, A is preferred to C. The assumption that leads to this conclusion is:
A) all goods are good.
B) diminishing MRS.
C) assumption of rationality.
E) completeness. 1) 2) An upward sloping indifference curve defined over two goods violates which of the following
assumptions from the theory of consumer behavior?
A) more is preferred to less.
C) preferences are complete.
D) all of the above
E) none of the above 2) Alvinʹs preferences for good X and good Y are shown in the diagram below. Figure 3.1
3) Based on Figure 3.1, it can be inferred that:
A) Alvin will never purchase any of good Y.
B) Alvin does not consider good X as ʺgood.ʺ
C) Alvin regards good X and good Y as perfect complements.
D) Alvin regards good X and good Y as perfect substitutes.
E) none of the above 1 3) 4) Refer to Figure 3.1. Which assumption concerning preferences do Alvinʹs indifference curves
A) Diminishing marginal rates of substitution
B) More is preferred to less
C) Transitivity of preferences
D) Completeness 4) Figure 3.3
5) Refer to the indifference curve in Figure 3.3. Which of the following statements is correct?
A) This individual will only consume A and B in fixed proportions.
B) This individual receives no satisfaction from Good A.
C) This individual receives no satisfaction from Good B.
D) none of the above 2 5) 6) Theodoreʹs budget line has changed from A to B. Which of the following explains the change in
Theodoreʹs budget line? 6) A) The price of food and the price of clothing increased.
B) The price of food decreased, and the price of clothing increased.
C) The price of food increased, and the price of clothing decreased.
D) The price of food and the price of clothing decreased.
E) none of the above
7) An increase in income, holding prices constant, can be represented as:
A) a parallel outward shift in the budget line.
B) an outward shift in the budget line with its slope becoming flatter.
C) a parallel inward shift in the budget line.
D) a change in the slope of the budget line. 7) 8) The change in the price of one good has no effect on the quantity demanded of another good.
These goods are:
C) both Giffen goods.
D) both inferior.
E) none of the above 8) 9) Which of the following is true regarding income along a price - consumption curve?
A) Income is constant.
B) Income is decreasing.
C) The level of income depends on the level of utility.
D) Income is increasing. 9) 3 10) If an Engel curve has a positive slope
A) both goods are normal.
B) the good on the horizontal axis is normal
C) as the price of the good on the vertical axis increases, more of the good on the horizontal axis
D) as the price of the good on the horizontal axis increases, more of both goods in consumed. 10) 11) For an inferior good, the income and substitution effects
A) work against each other.
B) work together.
C) can work together or in opposition to each other depending upon their relative magnitudes.
D) always exactly cancel each other. 11) 12) A Giffen good
A) is the special subset of inferior goods in which the income effect dominates the substitution
B) is the special subset of inferior goods in which the substitution effect dominates the income
C) is always the same as an inferior good.
D) must have a downward sloping demand curve. 12) 13) Assume that beer is a normal good. If the price of beer rises, then the substitution effect results in
the person buying __________ of the good and the income effect results in the person buying
__________ of the good.
A) less, more
B) more, less
C) more, more
D) less, less 13) 14) When a good is price inelastic, consumer expenditures on the good
A) are not related to price elasticity of demand.
B) do not change when price increases.
C) decrease when price increases.
D) increase when price increases. 14) 15) Use the following two statements to answer this question:
I. The price elasticity of demand is constant along the entire length of a linear demand curve.
II. The price elasticity of demand is the special name that economists give to the slope of a
A) I is false, and II is true.
B) I and II are true.
C) I is true, and II is false.
D) I and II are false. 15) Part 2: Long questions, 20 points each question. Write your answers in the space provided below. If your answers are
non-integar, keep them up to 3 decimal points. If you need extra space, feel free to use the back of the exam pages (with
clear reference to question numbers).
16) Donald derives utility from only two goods, carrots (Qc) and donuts (Qd). His utility function is as follows:
U(Qc,Qd) = 2*ln(Qc)+ ln(Qd) Donald has an income (I) of $120 and the price of carrots (Pc) and donuts (Pd) are both $1. 4 a. Write down the equation for Donaldʹs budget line. b. Is the utility function Cobb- Douglas ? c. What quantities of Qc and Qd will maximize Donaldʹs utility? Describe how you get the answer. d. Suppose that a tax of $1 per unit is levied on donuts. How will this alter Donaldʹs utility maximizing
choice of carrots and donuts? Describe how you get the answer. e. Instead of the per unit tax in (d), the government levies a lump sum tax of $30 on Donald (and keep the
prices of carrots and donuts at $1), whatʹs Donaldʹs utility maximizing choice of carrots and donuts? 5 17) The world demand for power transmission wire is made up of both domestic and foreign demands. Thus, the
total demand is the sum of the two sub - demands, which are given as:
Domestic demand: Pd = 5 - 0.005Qd
Foreign demand: Pf = 4 - 0.001Qf, where Pd and Pf are in dollars per pound, and Qd and Qf are in pounds per day.
a. Rewrite domestic demand so that Qd is a function of Pd. Rewrite foreign demand so that Qf is a function of
Pf. Assuming free trade so that domestic price and foreign price are the same. Determine the world demand for
power transmission wire. b. Determine the prices at which domestic and foreign buyers would enter the market. (Hint: the entering
price may be different for domestic and foreign buyers.) c. What is the price elasticity of the total world demand at P = $2.50 per pound? Is the total world demand
elastic or inelastic at this price? d. How much consumer surplus will be reduced if price increases from P =2.50 per pound to P=$4.5 per
(Hint: calculate the total world consumer surplus at the two prices searately and then compute their
difference.) 6 Answer Key for Midterm #1 1) D 2) A 3) D 4) A 5) C 6) B 7) A 8) E 9) A 10) B 11) A 12) A 13) D 14) D 15) D 16) a. Budget line: 120 = Qc + Qd b. Yes, it is a Cobb‐Douglas utility function because it can be rewritten as U=ln(X2Y). Any monotonic transformation of a Cobb‐Douglas utility is still a Cobb‐Douglas utility. c. The optimal choice must satisfy: MUc/MUd = Pc/Pd Substituting for MUd, MUc, Pd, and Pc yields: 2Qd/Qc = 1 or Qc = 2Qd Substituting the information in (b) into the budget line: 120 = 2Qd + Qd = 3Qd Qc = 80 Qd = 40. d. The $1 tax on donuts raises the after-tax price to $2. The income-consumption curve becomes: MUd/MUc = Pd/Pc Substituting for MUd, MUc, Pd and Pc yields: 2Qd/Qc = 1/2 or Qc = 4Qd The budget line is: 120 = Qc + 2Qd Substitute the income-consumption curve into the budget line to eliminate Qc: 120 = 4Qd + 2Qd = 6Qd Qd = 80 Qc = 20 e. If Donald paid $30 in a lump sum tax, his income would be $90. Resolve the utility maximization problem with I = 90, Pc = Pd = 1. The utility maximizing market basket is Qc = 60, Qd=30. 17) a. To calculate world demand, the two demands must be added together. We must express the sum of quantities demanded in terms of price. Thus, Each expression must be solved in terms of quantity. Domestic: Qd= 1,000 – 200*Pd Foreign: Qf= 4,000 – 1000Pf Total: Q=5000‐1200P if P<4, Q=1000‐200P if 4<P<5. b. Domestic buyers enter the market at Pd ≤ 5. Foreign buyers enter the market at Pf ≤ 4. c. At P = $2.50 per pound: Qd = 1,000 - 200(2.5) = 500 pounds per day. Qf = 4,000 - 1000(2.5) = 1500 pounds per day. Q = 5,000 – 1200*2.5 = 2000 pounds per day. Check: Qd + Qf = Q 500 + 1500 = 2000 Price elasticity at P=2.5: Ep=(dQ/Q)/(dP/P)=(dQ/dP)*(P/Q)=‐1200*2.5/2000=‐1.5. The total demand is elastic because the absolute value of Ep is bigger than 1. d. At P=2.5, consumer surplus for domestic = ½ * (5‐2.5) * 500 =625. Consumer surplus for foreign = ½*(4‐
2.5)*1500=1125. So the total consumer surplus = 625+1125=1750. At P = $4.5 per pound, only domestic buyers enter the market; therefore, the world demand equation is not the appropriate equation to use in this case. We must use only the domestic demand equation. Qd = 1000 - 200(4.5) = 100 pounds per day Consumer surplus = ½ * (5‐4.5)*100=25. Total consumer surplus is reduced by 1750‐25=1725. ...
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