econ501amidansw09 - The Ohio State University Department of...

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The Ohio State University Department of Economics Econ 501.02 Winter 2009 Prof. James Peck Midterm Examination Questions and Answers Part I: Short Answer. 1. (10 points) Suppose a consumer derives utility from food (good x )and clothing (good y ). The consumer has cash income, M = 200 , and faces prices, p x =2 and p y =10 . In addition to her cash income, the consumer receives from the government 100 in food stamps, which can be used to purchase food but not clothing. Using a carefully drawn and labeled graph, indicate the set of consumption bundles that the consumer can a f ord. (You need to put numbers on the axes so that I can see the amount of each good corresponding to any point in the graph.) Answer: The x intercept is 150, because both money and food stamps can be used to purchase food. The y intercept is 20, because only money can be used to purchase clothing However, the budget set’s boundary is not a straight line. Starting at (0,20), the consumer can use food stamps to purchase food with no reduction in clothing consumption, so the budget frontier has a horizontal segment from (0,20) to (50,20). From (50,20), further increases in food consumption entail a reduction in clothing consumption, based on the price ratio 1/5, so the budget frontier has a segment with slope -1/5 from (50,20) to (150,0). 1
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0 1 0 1 5 x 150 125 100 75 50 25 0 y 20 15 10 0
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2. (10 points) True or False, and explain: Considering the "textbook" case in which a consumer’s budget equation is p x x + p y y = M ,thentheincome e f ectduetoanincreasein p x will go in the opposite direction of the substitution e f ect if x is an inferior good. Answer: The statement is true. For all goods, the substitution e f ect of a price increase is to reduce the demand for good x , substituting away from the relatively more expensive good. Because purchasing power has gone down, the income e
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econ501amidansw09 - The Ohio State University Department of...

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