Chapter 5 - Answers to Questions for Review 1 Because...

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Answers to Questions for Review 1. Because gasoline is relatively more expensive than other goods after the tax, consumers substitute away from it and will spend only part of the tax rebate on gasoline. Consequently the consumption of gasoline does fall, but not as much as it would if the rebate were not given. 2. A two-part pricing scheme exists when a seller charges a initiation fee or cover charge and then a per unit charge as well. This is an attempt on the part of the seller to capture as much consumer surplus as possible. 3. The demand of each individual will be different, but the industry demand for education will surely be more inelastic than the demand facing any given school. 4. Heavy drinkers are generally lower income and consume a sizable portion of their budget in alcohol. Therefore the income effect is stronger than is often thought. 5. The interest rate is the premium required to move future income to the present. Since future goods are on the vertical axis and present goods are on the horizontal axis the budget line becomes an exchange rate between future and present income. 6. other goods ($/year) gas (gal/year) a b q1 q0 The most important reason is the increase in income. Assume that, 30 years ago, the budget constraint was b and the optimal consumption was q0. Although the price of gas has increased, so has income. The budget constraint (a) has become steeper, but it has also shifted outward. Optimal consumption increases to q1, despite the increase in price. 7. According to the permanent income hypothesis, consumption in each year is a constant proportion of the present value of lifetime income, or permanent income. Jennifer's lottery winnings more than double her current income, but have a much smaller proportional effect on her permanent income. So the proportional increase in her current consumption should be smaller than the proportional increase in her current income.
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Answers to Chapter 5 Problems 1. Other goods ($/year) Yr - Pe Yr - 2Pe Yp - Pe Yp - 2Pe 1 Y* (Yr - Pe)/Pe Quality of Education The rich family has income (Yr), the poor family has income (Yp), where Yr>Yp. The two families have the same indifference maps. The rich family's budget constraint is the heavy line, and the poor family’s budget constraint in the thinner one. The poor family maximizes utility by purchasing only public education (i.e., 1 unit of quality), but the rich family buys Y*>1 units of private education. 2.
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Chapter 5 - Answers to Questions for Review 1 Because...

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