Q1F10AnswerExplained

Q1F10AnswerExplained - October 20, 2010 Quiz 1 Economics 1...

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October 20, 2010 Quiz 1 Economics 1 True-False Questions: Fill in Bubble A for True, Bubble B for False. 1. Inferior goods are an exception to the Law of Supply. Answer: False The Law of Supply holds that the supply of a good increases as its price increases. An inferior good is a good for which a household‘s demand declines as its income increases. See Taylor, page 158. 2. For the outcome of trade to be efficient, buyers with the highest buyer value must buy from sellers with the lowest seller cost. Answer: False A competitive equilibrium is efficient, so let‘s think about trades in a competitive equilibrium. Suppose that the competitive equilibrium price is $20. Every buyer with buyer value greater than $20 will buy the good, and every seller with seller cost less than $20 will sell the good. Suppose there are some buyers with buyer values of $40 and some buyers with buyer values of $30. Suppose there are some sellers with seller costs of $5 and some with seller costs of $15. Both types of buyers will buy in a competitive equilibrium, and both types of sellers will sell. But, total profit is the same if the buyers with a buyer value of $40 buy from the sellers with a seller cost of $5 and the buyers with a buyer value of $30 buy from the sellers with a seller cost of $15 as it would be if the $40 buyers bought from the $15 sellers and the $30 buyers bought from the $5 sellers. 3. If Juanita is spending her income to maximize her utility, the marginal utilities from all the goods she consumes must be equal. Answer: False When Juanita is maximizing her utility, the ratio of the marginal utilities of any two goods she buys must equal the ratio of the prices of those goods. See Taylor, page 156. Consequently, if the prices of two goods are different, their marginal utilities will also be different.
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4. If the demand for avocadoes is price elastic, an unusually large avocado harvest means that avocado farmers will have higher revenue than usual. Answer: True An unusually large avocado harvest means that the supply curve of avocadoes will shift out to the right and the equilibrium will move down the demand curve. The price of avocadoes will fall, and the quantity of avocadoes will rise. The increase in quantity has a positive effect on the revenue of avocado farmers, but the decrease in price has a negative effect. Which effect will dominate? We know that the percentage change in revenue is approximately equal to the percentage change in price plus the percentage change in quantity. (See the lecture of October 11.) The price elasticity of demand is the percentage change in quantity divided by the percentage change in price. If demand is elastic, this price elasticity is less than -1, meaning that the percentage change in quantity is larger than the absolute value of the percentage change in price.
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Q1F10AnswerExplained - October 20, 2010 Quiz 1 Economics 1...

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