ECONOMICS ­ SIXTH YEAR
UNIT 5. HOMEWORK EXERCISES
1. A consumer's income is 50 EUR. Public transportation (X) costs 5 EUR per unit and films (Y) 2 EUR per unit. Transportation and films are normal goods for the individual.
(a) Draw the budget line.
(b) Draw point e=(4,15) as the optimal consumption bundle.
(c) Now, the price of food fails to 2.50 EUR. Use graphs to show what happens to the consumption of food if
i. we only consider the substitution effect. ii. we consider the total effect (i.e., the sum of substitution and income effects?
(d) The price of films also falls to 1 EUR. Draw the new optimal consumption bundle
2. Suppose now that food (Y) is still a normal good but public transportation (X) is an inferior good (but not Giffen good). Prices are PX=5 EUR and PY=2 EUR. Income of the average citizen is M=50 EUR. The initial consumption bundle is e=(4,15). The government wants to expand the use of public transportation. Discuss (using graphs) which of the two policies will best serve to the government purposes:
(a) A tax on consumption goods of 1 EUR per unit.
(b) An income tax of 25 EUR.
(c) The Democratic Party in office proposes the method chosen in the previous analysis in their campaign for local elections. The Citizen's Party, now in the opposition, proposes instead to establish a subsidy on the price of public transportation such that the price falls to 1 EUR. People will vote to the party that provides them with higher utility. Discuss using graphs who will be the next major of the city. 3. Discuss why the following statement is wrong: “As long as Giffen goods don't exist in the economy, inflation must reduce demand of all goods no matter they are normal or inferior, since prices of all goods are higher and thus all of them are more expensive”.
Quiz Test
1. The budget constraint describes:
(a) the limit to the working week
(b) the different bundles that the consumer can afford
(c) the prices faced by the consumer
(d) the consumers income
2. Points to the right of the budget line _______ and points to the left _______.
(a) Are unaffordable, allow extra spending
(b) Allow extra spending, are unaffordable
(c) Are unaffordable, use up the entire budget
(d) Allow extra spending, use up the entire budget
3. For a budget line representing 2 goods, the slope depends on the ratio of the prices.
(a) True
(b) False
4. If the price of films is 12EUR (on the vertical axis) and the price of meals is 3EUR (on the
horizontal axis), the slope of the budget line for these two goods is:
(a) +4
(b) 4
(c) +. 25
(d) -.25
5. If consumption bundle A is preferred to consumption bundle B and B is preferred to C then:
(a) B is preferred to A
(b) C is preferred to B
(c) C is preferred to A
(d) A is preferred to C
6. The marginal rate of substitution of meals for films is the quantity of films the consumer must
sacrifice to increase the quantity of meals by one unit _______ .
(a) while increasing total utility
(b) while reducing total utility
(c) without changing total utility
(d) none of the above
7. Consumer tastes exhibit a diminishing marginal rate of substitution, to hold utility constant,
___________ quantities of one good must be __________ to obtain successive equal increases
in the quantity of the other good.
(a) diminishing, increased
(b) increasing, sacrificed
(c) diminishing, sacrificed
(d) increasing, increased
8. Indicate which assumption is not required to represent consumer tastes:
(a) consumers prefer more to less.
(b) consumers can rank alternative bundles according to the utility provided.
(c) consumers have tastes satisfying a diminishing marginal rate of substitution.
(d) consumers always buy quality products.
9. The budget line shows affordable bundles.
(a) True
(b) False
10. If indifference curves intersect, a consumer will prefer a point as far to the northwest as
possible.
(a) True
(b) False, indifference curves can't intersect.
11. If consumption bundle A is to the northwest of consumption bundle B, A _______ B.
(a) Is preferred to
(b) Is dominated by
(c) is indifferent to
(d) May or may not be preferred to
12. The quantity of one good that a consumer must sacrifice to increase the consumption of
another, without changing total utility is known as ___________.
(a) the opportunity cost
(b) the marginal utility
(c) the marginal rate of substitution
(d) the production possibility frontier
13. Diminishing marginal rates of substitution suggest that more and more of one good must be
sacrificed to get more and more of another.
(a) True
(b) False
14. When a budget line just touches an indifference curve the consumer _______ and ________.
(a) has money left over, is on the highest possible indifference curve
(b) has exhausted her budget, is not on the highest possible indifference curve
(c) has insufficient funds, is on the highest possible indifference curve
(d) has exhausted her budget, is on the highest possible indifference curve
15. Along each indifference curve, utility is _______.
(a) increasing
(b) decreasing
(c) constant
(d) bliss
16. An increase in income will cause a consumer s budget line to __________.
(a) shift outwards parallel to the original budget line
(b) shift inwards parallel to the original budget line
(c) shift inwards parallel to the original budget line remain unchanged
(d) rotate
17. A budget line will rotate when
(a) income changes
(b) relative prices change
(c) tastes change
(d) the marginal rate of substitution changes
18. Any price change can be decomposed into an income effect and a complementary effect.
(a) True
(b) False
19. A price increase will have a ________ income effect and a ________ substitution effect on an
inferior good.
(a) negative, positive
(b) negative, negative
(c) positive, positive
(d) positive, negative
20. The income effect of a price increase of a normal good is to __________ of that good and the
substitution effect is to _______ of that good.
(a) increase quantity demanded, reduce quantity demanded
(b) increase quantity demanded, increase quantity demanded
(c) reduce quantity demanded, reduce quantity demanded
(d) reduce quantity demanded, increase quantity demanded