Key for Sample Exam 1

Key for Sample Exam 1 - (multiple choice, 2 points) The...

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Unformatted text preview: (multiple choice, 2 points) The aggregation of linear individual demand curves gives a market demand curve that is linear as well under the following circumstances: a. b. c. d. (short answer, 6 points) It is wellknown that economists generally favor free trade over trade restrictions or no trade at all. What assurance is there that the complete integration of two formerly isolated markets will, in fact, make all parties better off? Always. Never. When the individual demand curves are all the same. None of the above. (multiple choice, 2 points) For a straightline demand curve, a. b. c. d. e. demand is highly price elastic near the vertical intercept of the demand curve. demand is highly inelastic near the horizontal intercept. demand is unit elastic at the midpoint. All of the above. None of the above. There can be no such assurance in general. It is possible in principle that everyone would benefit, or that some parties would gain at the same time that no one is made worse off. [That is what we will call a `Pareto improvement' later on.] But, as was the case with the homework problem, it is altogether likely that the price of the traded product would go up to some buyers who are not otherwise compensated, and that the price of the traded product would fall for some sellers who are not otherwise compensated. (multiple choice, 2 points) For the case of perfect complements, a. b. c. d. (short answer, 6 points) Andrew has a fixed amount of money to spend on beer and soda. His optimum consumption point is indicated in the graph as point A. a. b. c. Draw an indifference curve for Joe that shows that this is, in fact, a consumer's optimum for him. At this point, is he spending more money on beer or soda, and how do you know? His consumption choices of soda and beer are "independent" in the sense that his priceconsumptioncurve for changes in the price of beer shows no change in his consumption of soda, and his priceconsumption curve for changes in the price of soda shows no change in quantity of beer consumed. Draw these curves, passing through point A. Show two more budget lines, one reflecting a lower price of beer, the other instead reflecting a lower price of soda. Determine Andrew's new consumption choices in either situation. the priceconsumption curve for a changing price of the good on the horizontal axis will be steeper than the incomeconsumption curve. the priceconsumption curve for a changing price of the good on the vertical axis will be steeper than the incomeconsumption curve. the priceconsumption curves coincide with the incomeconsumption curve. None of the above. (multiple choice, 2 points) Michael is willing to trade off four 12ounce cans of soda for one 12ounce bottle of beer, always. Then a. b. c. d. his indifference curves are straight lines, and beer and soda are perfect substitutes. his indifference curves are straight lines, and beer and soda are imperfect substitutes. his indifference curves are all Lshaped, with the kink points where he consumes four cans of soda for every bottle of beer. None of the above. soda PCC for a changing price of soda C A B PCC for a changing price of beer d. indifference curve a. b. beer c. d. See graph. Andrew is spending more money on soda. That is because his chosen combination lies above the midpoint of the budget line, marking the case where he spends equal amounts. (If he spent all his money on soda, the chosen combination would be given by the vertical intercept of the budget line.) See graph. The intersections of the budget lines with the respective priceconsumption curves show the new optimum combinations. Point B is the new combination at a lower price of beer. Point C is the new combination at a lower price of soda. (multiple choice, 2 points) Suppose the demand for coffee falls by 30%. Then at every price the demand for coffee will be a. b. c. d. (short answer, 6 points) Lauren is on a limited budget for food and medicine. (Some would say she is `forced' to choose between these two items.) Her initial consumer's optimum is found at point A in the graph. Suppose now that the price of the medicine she takes goes up, and at the same time that the price of food goes down, and these two changes are such that her new budget line passes exactly through her initial consumption point. a. b. Will she purchase more food than before, or less, or the same amount as before? How do you know? With the change, will she be better off, worse off, or the just as well off as in the initial situation? How do you know? more elastic than before. less elastic than before. just as elastic as before. Any of the above are possible. (multiple choice, 2 points) If one there are only two goods for some consumer, and one of them is a Giffen good, then according to the sign of the crossprice effect as the price of the Giffen good rises, the goods would have to be regarded as a. b. c. d. complements. substitutes. independents. None of the above (can't tell). food new budget line B A a. She will buy more food than before. The two price changes lower the relative price of food. Also, the new budget line is said to pass through A; the new budget is shown in the graph. Knowing that point A is her initial optimum, an indifference curve must be tangent to the initial budget line at point A. Then the new budget line intersects that indifference curve at point A. This opens up combinations that are now affordable that previously weren't, and which lie above the initial indifference curve. The new optimum combination must be found to the upper left of point A. It will be at a point such as point B. The same graph shows that she will be better off, as point B will lie to the upper right of her initial indifference curve. Another way to look at this is to note that combination A is affordable in both situations, but in the new situation point B is chosen instead, so B must make her better off. medication b. (multiple choice, 2 points) When does the principle that for an optimizing consumer, the marginal utility per dollar spent should be the same for every good, not necessarily apply? a. b. c. d. (short answer, 6 points) Kathryn is working on a salary that is reflected in the budget line on the right, showing purchasing opportunities for food and all other goods. Her salary is indexed to general inflation. Then the price of food rises, which will be reflected in a rise in the overall level of prices as measured by the consumer price index (CPI) by 5%. The price index indicates how much more in salary she would need to purchase the initial bundle, in this case 5%. In consequence her salary is, in fact, adjusted upward by 5%. With all these changes, will Kathryn be better off than before, worse off, or the same? Why? It does not have to hold for goods not actually purchased. It need not hold when there is a corner solution. a. and b. None of the above. (multiple choice, 2 points) The best way to describe the concept of a utility function in consumer theory is that it is a function that is a. b. c. d. e. ordinal. cardinal. cordial. convivial. None of the above. all other goods A initial indifference curve new budget food She will be better off. The adjustment of her salary gives her the option to purchase the initial combination, represented by point A in the graph. But now the relative price of food is higher than before, which is to say that the new budget line is steeper. The initial budget line was tangent to the indifference curve at point A. The new, steeper budget line therefore has to intersect the indifference curve at point A. She is free to move to the upper left along the new budget line, which puts her above her initial indifference curve, meaning she is better off after the change. (multiple choice, 2 points) When "more is better" for a consumer and the consumer's indifference curves are not everywhere convex, then any consumer's optimum a. b. c. d. [The indicated answer is the best answer. But the first answer, a., is correct for any interior solution. That is more of a twist than I normally like, and when I gave this exam I gave credit for both a. and d.] (short answer, 6 points) Sarah's consumption choices for three different budgets for milk and cookies are indicated on the right. Her initial optimum bundle is found at point A. Bundles B and C reflect changes in the price of cookies and milk, respectively. These are her new optimum choices. a. b. c. Do cookies satisfy the law of demand, or are they a Giffen good for Sarah? Does milk satisfy the law of demand, or is milk a Giffen good for her? Using the direction of the crossprice effect to indicate "substitutes" vs. "complements," is milk seen to be a substitute for, or a complement to, cookies when the price of cookies is changing? As the price of milk is changing, are cookies found to be a substitute for, or a complement to, milk? milk (multiple choice, 2 points) will fall on a part of an indifference curve that is convex. cannot ever be determined. must involve a bliss point. None of the above. PCC for changing price of milk B A C PCC for changing price of cookies d. a. cookies b. c. d. I have added two priceconsumption curves to the graph (not required but helpful). The curve passing through A and B reflects the change in the price of cookies. The curve passing through A and C reflects the change in the price of milk. Cookies are not a Giffen good for Sarah. The increased price of cookies causes her to cut down on her consumption of cookies (movement from A to B). As the price of milk rises, her consumption of milk diminishes (movement from A to C). Milk, too, is not a Giffen good. The increased price of cookies causes her to buy more milk, so that one would regard milk as a substitute for cookies. The increased price of milk causes her to buy fewer cookies, so that one would regard cookies as a complement to milk. [In view of c., this seems not to make a whole lot of sense. Milk is a substitute for cookies and cookies are a complement to milk? But it does conform with the definition of substitutes and complements that is based on the signs of the crossprice effects. Also, note that it would be easy to draw an indifference curve that is tangent to the respective budget lines at B and C. In other words, this graph does not require indifference curves that conflict with the general assumptions of our consumer theory. There is no basis on which to rule this out in the general case.] (multiple choice, 2 points) Stephanie is a rational consumer purchasing only two goods, walnuts and cheddar cheese. Then which of the following cannot apply? a. b. c. d. (short answer, 6 points) Cigarettes are an inferior good for Timothy. At present he is purchasing a positive quantity of cigarettes. He only consumes food and cigarettes. a. b. Draw his incomeconsumption curve and briefly explain why it looks as it does. Is it possible for two goods to be inferior when there are only two goods? Why, or why not? As the price of cheddar cheese diminishes, her consumption of both goods goes up. As the price of cheddar diminishes, her consumption of walnuts rises and her consumption of cheddar falls. As the price of cheddar diminishes, her consumption of both goods diminishes. None of the above. (multiple choice, 2 points) Ryan is a rational consumer purchasing only two goods, rice and beans. Then which of the following situations cannot apply? a. b. c. d. e. Both rice and beans are normal goods. Rice is a normal good and beans are an inferior good. Rice is a Giffen good. Both rice and beans are inferior goods. None of the above. food income-consumption curve a. As income rises (parallel outward shift of the budget line) his consumption of cigarettes falls and his consumption of food must rise. See graph. The two points not on the initial budget line are showing consumption combinations for incomes above and below the initial income. This is not possible. As income rises and all of it is spent and the prices are the same as before, if less of something is bought, more of something else must be bought. If it were the case that Timothy, or any other consumer, bought less of both goods, or less of one good and the same amount of the other, there would be funds left over, which would contradict the basic condition of `more is better,' meaning that there is always at least one good of which more is desired. cigarettes b. (multiple choice, 2 points) The standard theory of the rational consumer a. b. c. d. (short answer, 6 points) For the market described on the right, find a. b. c. the equilibrium price and quantity, as well as the price elasticity of demand at the equilibrium price, and the price elasticity of supply at the equilibrium price. (multiple choice, 2 points) A consumer may be "compensated" for a change in price in the following ways: a. b. c. d. maintaining exact affordability of the initial bundle. keeping the consumer on the initial indifference curve. Both a. and b. None of the above. implies that the law of demand always holds. requires measurable utility for every consumer. requires a static framework, but choices over time cannot be addressed. None of the above. D: S: 28 12 4 12 a. b. c. Here . The quantities are the same at equilibrium so that That is . , or . This uses the coefficient , or . . Plugging in gives . , or . from the demand equation. , or 1.67. Here the coefficient comes from the supply function. (multiple choice, 2 points) At a consumer's optimum that is not a corner solution, a. b. c. d. e. (short answer, 6 points) The graph on the right is a representation of the market for cigarettes. The percentages indicated in the graph are expressed in reference to the market equilibrium point in the absence of a tax. (The graph is not drawn to scale.) a. b. c. Using the numbers (percentages) shown in the graph, find the price elasticity of demand and the price elasticity of supply. What is the ratio of the effective burden of the tax on buyers vs. sellers? Is there a general relationship between this ratio of the tax burdens and the demand and supply elasticities? budget line and indifference curve are tangent. the marginal utility per dollar spent is the same for both goods. MRS = MRT. the dollar cost of raising utility by a given amount is the same for both goods. All of the above. (multiple choice, 2 points) We can analyze consumer choice in a graph that places spending on all other goods on the vertical axis. In doing so it is assumed that a. b. c. d. the consumer optimizes over all other goods, given their prices. the consumer chooses the other goods in exact proportions that do not change. the dollar prices of the other goods may change as long as compensation for any utility losses is made. None of the above. price 45% S 15% D 30% quantity a. b. c. [Going further/making the reasoning more precise/more than enough: The ratio of the burdens of the tax is equal to . . which, by expansion and rearranging, can also be written as . . . . And that is just the ratio of the two elasticities.] Compared with the case of a zero tax, the quantity demanded falls by 30% as price to buyers rises by 45%. The price elasticity of demand is the ratio of the two and equal to 2/3. Similarly, quantity supplied falls by 30% as price to sellers falls by 15%, which means that the supply elasticity is equal to 2. That ratio is equal to 45% / 15% = 3. Yes, there is. In this case, supply is 3 times as elastic as demand, and buyers are bearing 3 times as much of the burden of the tax as do sellers. This works for any multiple of elasticities and burden ratios, as can be seen by substituting any other set of percentages. ...
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This test prep was uploaded on 04/08/2008 for the course ECON 605 taught by Professor Schmidt during the Spring '08 term at New Hampshire.

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