Midterm 1 Solutions

# Midterm 1 Solutions - Fall2011 Prof.Santesteban...

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Econ 100A – Microeconomic Analysis Fall 2011 Prof. Santesteban Dept. of Economics U.C. Berkeley You have 80 minutes to complete the exam – from 11:10 to 12:30. Please write your name, student ID number, and GSI at the top right of this page. Please write your ID number on every other page of this exam. You may use a simple calculator – no graphing calculators. No other reference material is allowed, i.e., no cheat sheets. If you have a question, please raise your hand and wait for a GSI to come. If you need more scratch paper, raise your hand and request it from a GSI. Good luck! Midterm Exam 1 SOLUTIONS Part I True/False/Uncertain (and One Multiple Choice) – 2 points each Please explain why. You will not get any credit if you just write True/False/Uncertain without an argument. 1. Consider a consumer with a fixed income in a two good setting. The change in the budget line is the same whether a) both prices simultaneously fall by half while the dollar income remains the same or b) the dollar income doubles while prices remain the same. TRUE: This can be seen by rewriting the budget line (p1*x1 + p2*x2 = M) as x2 = M/p2 – x1*p1/p2. If both prices fall by half, then the budget line becomes: x2 = 2M/p2 – x1*p1/p2. This causes the y intercept to double. If, on the other hand, income doubles, the effect on the budget line is the same: x2 = 2M/p2 – x1*p1/p2. Hence, the statement is true. 2. Angela’s utility function is U(x1, x2) = (x1 + x2) 3 . Her indifference curves are downward sloping, parallel straight lines. TRUE: Angela’s indifference curves are downward sloping if the marginal rate of substitution is negative. MRS = MU 1 /MU 2 MU1 = 3(x 1 +x 2 ) 2 MU2 = 3(x 1 +x 2 ) 2 MRS = 1

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The indifference curves are parallel straight lines because the MRS is constant as indicated above. Changes to the level of utility will result in parallel indifference curves. 3. Sharon spends all of her income on peaches and strawberries. Peaches are a normal good for her. Her income increased by 20 percent and prices did not change. Her consumption of strawberries could not have increased by more than 20 percent. FALSE: Sharon’s consumption of strawberries may increase more than 20%. If the price of both was initially 1 and let’s say that her income was 50 and she consumes 25 of each. After her income increases to 60, let’s say she consume 26 peaches. Her consumption of strawberries would now be 34 – more than 20% increase. 4. A rational consumer prefers more of good x to less. If the price of good x rises and the prices of all other goods remain constant, then the consumer must necessarily demand less of x. FALSE: In the case of a Giffen good, an increase in the price will result in an increase of the quantity demanded for that good. The substitution effect will lead the consumer to demand less of the good in favor of all other goods but the income effect resulting from a decrease in expenditure will lead the consumer to purchase more of the good. Overall, the income effect will dominate the substitution effect.
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## This note was uploaded on 11/03/2011 for the course ECON 100A taught by Professor Woroch during the Fall '08 term at Berkeley.

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Midterm 1 Solutions - Fall2011 Prof.Santesteban...

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