exam1_sol_f01

Name

Davidson College Mark C. Foley Department of Economics Fall 2001 Intermediate Microeconomic Theory

Review #1

Selected Suggested Solutions

Section I: Multiple Choice

Indicate the best answer in the space provided to the right of each question.

1. If both supply and demand decrease at the same time, which of the following B must also decrease?

(a) the equilibrium price

(b) the equilibrium quantity

(c) the use of substitutes

(d) the use of complements

(e) none of the above

2. The assumption of nonsatiation says that C

(a) to consume more of one good, we must give up consumption of a second good.

(b) more consumption will decrease total utility.

(c) more of anything is always better.

(d) more consumption will not lead to a change in total utility.

(e) consumers reach a point where they cannot consume more of anything.

3.Jane consumes only xylophones and yams. If we graph Jane’s indifference D curves with xylophones on the horizontal axis and yams on the vertical axis,

then whenever she has more yams than xylophones, the slope of her indifference curves are –2. Whenever she has more xylophones than yams, the slope is –1/2. Jane would be indifferent between a bundle with 24 xylophones and 36 yams and another bundle with 34 xylophones and

(a) 28 yams.

(b) 32 yams.

(c) 22 yams.

(d) 25 yams.

(e) 26.50 yams.

4. Which of the following statements about demand-elasticity is correct? E

(a)if demand is price-inelastic, an increase in price will lower total expenditures.

(b)if demand is price-elastic, an increase in price will increase total expenditures .

(c)if demand is price-elastic, an increase in price will leave total expenditures

unchanged.

(d)If demand is unit-elastic, a decrease in price will decrease total expenditures.

(e)if demand is price-inelastic, a decrease in price will decrease total expenditures.

5. An individual considers goods X and Y to be perfect complements. Thus, D

(a) the Hicksian demand curve for X is steeper than the Marshallian demand curve.

(b) the Marshallian demand curve for X is steeper than the Hicksian demand curve.

(c) the Marshallian and Hicksian demand curves are coincident.

(d) the Hicksian demand curve is vertical.

(e) None of the above.

Since the Hicksian demand curve indicates only substitution effects and there are no substitution effects for perfect complements, the Hicksian demand curve is vertical in this special case.

6. In the graph below, the shock is a decrease in the price of yams. E (a) Yams are a normal good and substitutes for Xeroxes. (b) Yams are an inferior good and substitutes for Xeroxes. (c) Yams are a Giffen good.

(d) Yams are a normal good and complements for Xeroxes. (e) Yams are an inferior good and complements for Xeroxes.

Label the initial, intermediate, and final points “A”, “B”, and “C”, respectively.

The move from B to C represents the income effect. Therefore, since Y B > Y C , yams are inferior – consumption of yams fell when income (purchasing power) rose. The answer is either (b) or (e). The question becomes, are yams and Xeroxes substitutes or complements? Because the demand for Xeroxes increased (X C > X A ) when the price of yams decreased, they are complements. Answer = (e).

7. For a Cobb-Douglas utility function, βαY X Y X U =),( , D (a) preferences are homothetic.

(b) the share of income spent on good Y is unrelated to the price of good X. (c) the income-consumption curve is linear. (d) (a), (b), & (c) are true (e) only (a) & (b) are true

We have shown that C-D preferences are homothetic. We have shown that expenditure shares are constant for C-D preferences. (a) & (b) are true.

For (c), X* = αI/P X , and if I increases by t%, then so does X*. In other words, if an IC is tangent to the budget line at (x 1, y 1), then the IC which passes through (tx 1, ty 1) will be tangent to the “tI” budget line. That is the definition of an income -consumption curve. Xeroxes A C B Y