Prelim%201%20Solutions - 2

# Prelim%201%20Solutions - 2 - Economics 3010 Fall 2009...

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Economics 3010 Professor Daniel Benjamin Fall 2009 Cornell University EXAM #1 SOLUTIONS I. True / False / Uncertain Your grade on these questions will depend on the generality, completeness, and persuasiveness of your explanation, not simply on whether the “true” or “false” is correct. The objective here is to provide an answer that convinces; not merely an answer that is “not wrong.” At the very least, make sure that you give clear definitions for the relevant economic terms used in the question. Please use a separate blue book for this section. (5 points) 1) If Ann’s preferences can be represented by utility function U ( a , b ) = a + b , and Bob’s by U ( a , b ) = ( a + b )^3, then Ann and Bob have the same preferences. True. 1 points : A utility function represents a person’s preferences if and only if, for any two consumption bundles, the function assigns a (strictly) higher number to (strictly) more- preferred bundle. 2 points : Such a utility function is unique up to a monotonic transformation. 1 point : ( a + b )^3 is a monotonic transformation of a + b . 1 point : Hence Ann and Bob have the same preferences. (5 points) 2) If Samantha owns a lot of jewelry, it is a normal good for her, and the price increases, her demand for jewelry will unambiguously fall. False. 1 point : Since the relative price of jewelry increased, the substitution effect says that Samantha will buy less jewelry. 1 point : The “ordinary” income effect says that because Samantha’s purchasing power has fallen, and since jewelry is a normal good, she will buy less jewelry. 1 point : However, there is also an endowment income effect because Samantha owns a lot of jewelry. 1 point : According to the endowment income effect, the increase in the price of jewelry increases Samantha’s wealth, which makes her buy more jewelry (since jewelry is a normal good). 1 point : Hence the net effect of the price increase on Samantha’s demand for jewelry is ambiguous.

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(5 points) 3) If supply is highly inelastic while demand is not, then a tax imposed on suppliers will be mostly borne by suppliers. True. 1 point : The burden of the tax falls more on the side of the market that is more inelastic. 1 point : Hence in this case, the tax will be borne mostly by suppliers. 2 points
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Prelim%201%20Solutions - 2 - Economics 3010 Fall 2009...

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