Economics 310
Price Theory
First Exam-Spring 2001
Department of Economics
College of Business and Economics
California State University-Northridge
Professor Kenneth Ng
Thursday, July 13, 2017
Question 1

(40 points). John and Betty recently began living together. The
number of hours required to complete two household tasks for
each person are given in the table below.
1. Betty suggests that a fair way of dividing the household chores
is to take turns. One week she will wash the clothes and John
will cook dinner. The next week she will cook dinner and John
will do the laundry. Is this a good way of dividing up the
household chores. Explain using economic principles and
terminology.
2. Numerically demonstrate your answer.
3. Suppose John took a cooking course at the local community
college where he learned how to cook a meal in 15 minutes.
Explain using economic principles and demonstrate
numerically what effect this would have on John and Betty.
Wash Clothes
Cook Dinner
John
1 hours
2 hours
Betty
15 minutes
1 hour
Question 1 A
A.
Betty suggests that a fair way of dividing the household chores is to
take turns. One week she will wash the clothes and John will cook
dinner. The next week she will cook dinner and John will do the
laundry. Is this a good way of dividing up the household chores.
Explain using economic principles and terminology.
Wash Clothes
Cook Dinner
John
1/2
2
Betty
1/4
4
Betty’s plan is a bad way of dividing the chores. It would be
better for each person to specialize in the production of the good in
which they have a comparative advantage and exchange for the good in
which they have a comparative disadvantage.
Betty has a comparative advantage in washing clothes and
John has a comparative advantage in cooking dinner.
If they did this they could collectively and individually enrich
themselves.
Question 1B
Numerically demonstrate your answer. Computing opportunity cost yields
the following
John has the comparative advantage in cooking dinner. Betty has the comparative
advantage in washing clothes.
Start with the situation where each is washing their own clothes and cooking their
own meals:
John is cooking 7 dinners (14 hours) and doing 4 loads of laundry (4 hours) per
week-18 hours doing chores.
Betty is cooking 7 dinners (7 hours) and doing 4 loads of laundry (1 hour) per
week-8 hours doing chores.
They should now specialize in the production of the good in which they have a
comparative advantage.
Suppose Betty does 3 loads of John’s laundry in exchange for 1 dinners. Now
John is cooking 8 dinners and doing 1 load of laundry (17 hours) and Betty is
doing 7 loads of laundry and cooking 6 dinners (7.75 hours).
John is saving one hour and Betty is saving .25 hours.
Question 1C
Suppose John took a cooking course at the local community college where he learned how to
cook a meal in 15 minutes. Explain using economic principles and demonstrate
numerically what effect this would have on John and Betty.
Wash Clothes
Cook Dinner
John
4 dinners
1/4 loads of laundry
Betty
¼ dinner
4 loads of laundry
John still has the comparative advantage cooking dinner but the difference in opportunity costs
between John and Betty is now greater. Since they are now more different the gain to
specialization and exchange will be larger.
Use the same example from the previous slide where each is washing their own clothes and
cooking their own meals:
John is cooking 7 dinners (3.75 hours) and doing 4 loads of laundry (4 hours) per week7.75 hours doing chores.
Betty is cooking 7 dinners (7 hours) and doing 4 loads of laundry (1 hour) per week-8
hours doing chores.
If they specialize as before:
Betty does 3 loads of John’s laundry in exchange for 1 dinners. Now John is cooking 8
dinners and doing 1 load of laundry (3 hours) and Betty is doing 7 loads of laundry and
cooking 6 dinners (7.75 hours).
John is saving 4.75 hour and Betty is saving .25 hours.
Question 2

Consider a person who works 2000 hours a year, makes
$15/hr, and spends $500 per month on rent.
A.
B.
C.
1. Draw budget lines and indifference curves depicting this
individual. Label full both axes.
2. Suppose the individual received a raise to $20 per hour.
Show how this would affect his expenditures on housing if
housing were an inferior good. Show the substitution and
income effect of the increase in his wage.
3. Suppose the individual now got married and had a child.
What effect would this have? Explain using relative price and
marginal rates of substitution. Depict the change on your
graph.
Draw budget lines and indifference curves depicting this individual. Label full both axes. Suppose the
individual received a raise to $20 per hour. Show how this would affect his expenditures on
housing if housing were an inferior good. Show the substitution and income effect of the
increase in his wage.
Income
Since the slope of the
BL hasn’t changed, there
is no substitution effect.
$15/hour
$40,000
B
New optimum
I2
$30,000
Because housing is an
inferior good, the
amount of housing
chosen falls as his
income increases.
Income effect
A Initial optimum
$20/hour
I1
0
$6,000
Income effect
$30,000
$40,000
Housing
Suppose the individual now got married and had a child. What effect would this
have? Explain using relative price and marginal rates of substitution. Depict the
change on your graph.
Having children will make
housing more valuable
relative to other goods.
Income
B
This will cause the MRS
New optimum between housing and
income to increase and the
curve through a point
IIC
2
to become steeper (purple
to red).
$20/hour
I1
0
Housing
Question 3

Suppose that each month Lillian gets a $500 allowance from her parents for
clothing and entertainment. In March, she spends $300 on clothing and $200 on
entertainment. In April, she gets another $500 from her parents and spends $200
on clothing and $300 on entertainment.
A. If Lillian's preferences haven't changed what has happened to the relative
price of clothing? Use the axes below to depict and explain what has
happened on an indifference curve and budget line graph.
B. Does the change from part A create a substitution and income effect. Show
and explain on your graph.
C. Suppose the relative price of clothing changed from 2 to 1. Show the change
on an indifference curve/budget line graph. Indicate on the graph the income
and substitution effect of the change in relative price. Assume that clothing is
an inferior good.
D. In June, Lillian’s father decides its’ time “to learn the value of hard work,” so
orders her to get a job rather than just live off her allowance. Lillian gets an
offer to work as a sales clerk at her favorite stores--Fred Segal’s on Rodeo
Drive. The job pays $6/hour, she works 15 hours per week and she works 4
weeks each month. In addition, she gets 50% off clothing she buys in the
store. Depict the change in her budget line if she accepts the offer and her
father cuts her allowance from $500 to $250 per month.
E. Suppose Lillian’s father eliminates her allowance altogether. Is it possible that
Lillian will do something to get fired from her job so that she can go back to
being unemployed and collect a $500 allowance from her father? Use budget
lines and indifference curves to show and explain.
Suppose that each month Lillian gets a $500 allowance from her parents for clothing and entertainment.
In March, she spends $300 on clothing and $200 on entertainment. In April, she gets another $500
from her parents and spends $200 on clothing and $300 on entertainment.
If Lillian's preferences haven't changed what has happened to the relative price of clothing? Use the
axes below to depict and explain what has happened on an indifference curve and budget line graph
Entertainment
At point A, the price of clothing is $100
and the price of entertainment is $50.
10
If the price of entertainment increased
to $100, the BL would shift to the
purple dotted line.
5
4
3
0
A
B
2
3
5
Clothing
Suppose the relative price of clothing changed from 2 to 1. Show the change on an indifference
curve/budget line graph. Indicate on the graph the income and substitution effect of the change in
relative price. Assume that clothing is an inferior good.
Entertainment
The S-effect is shown from A to C.
10
The I-effect is shown from C to B.
Since clothing is an inferior good, the
decrease in income causes clothing
consumption to increase.
5
2.5
A
C
B
0
3
5
Clothing
In June, Lillian’s father decides its’ time “to learn the value of hard work,” so orders her to get a job
rather than just live off her allowance. Lillian gets an offer to work as a sales clerk at her
favorite stores--Fred Segal’s on Rodeo Drive. The job pays $6/hour, she works 15 hours per
week and she works 4 weeks each month. In addition, she gets 50% off clothing she buys in
the store. Depict the change in her budget line if she accepts the offer and her father cuts
her allowance from $500 to $250 per month.
Entertainment
6.1
5
3.6
0
Entertainment costs $100. Clothing costs
$100.
If she earns $360/month and gets a 50%
discount on clothing, she can buy 3.6 units
of entertainment or 10 units of clothing.
If she still gets $250 in monthly allowance
she can buy 6.1 units of entertainment or
12.5 units of clothing.
5
10
Clothing
Suppose Lillian’s father eliminates her allowance altogether. Is it possible that Lillian will do something
to get fired from her job so that she can go back to being unemployed and collect a $500
allowance from her father? Use budget lines and indifference curves to show and explain.
If her father completely takes
away her allowance she will
be forced onto the solid blue
budget line.
Entertainment
6.1
5
The purple IC’s show her
preferences when she would
prefer to get the $500
allowance and not work.
The green budget lines show
her preferences if she
continues to work even if she
could not work and get her
$500 allowance.
3.6
0
5
10
Clothing
Summary Statistics
Mean
Standard Deviation
Students Taking Exam
Students Enrolled in Class
Grade
A
B
C
D
F
Required Score
51
39
26
14
Without
Homework
27.1
12.3
With
Homework
33.2
16.8
73
Normalized
Score
2
1
-0.02
-1
Number
Receiving
Grade
9
20
21
14
9
Percent
Receiving
Grade
12%
27%
29%
19%
12%
Mandatory one week cooling off
period.
Questions regarding the exam will be
handled only in office hours
beginning next Tuesday.
BB4262, TTH 12:30-1:30 PM, T
9:30-10:30 AM