Question

1. Which of the following claims is true at each point along a price-consumption curve?

A) Utility is maximized but income is not all spent.

B) All income is spent, but utility is not maximized.

C) Utility is maximized, and all income is spent.

D) The level of utility is constant.

2.  Consider a graph on which one good Y is on the vertical axis and the only other good X is on the horizontal axis.  On this graph the income-consumption curve has a positive slope for low incomes, then it takes a zero slope for a higher income, and then it takes a negative slope for even higher incomes (the curve looks like an arc, first rising and then falling as income increases).  This curve illustrates that, for all income levels,

A) both X and Y are normal.   

B) only Y is normal.          

C) both X and Y are inferior.           

D) only X is normal.

3. Good A is an inferior good. If the price of good A were to suddenly double, the substitution effect would cause the purchases of good A to increase by

A) more than double.

B) exactly double.

C) less than double.

D) Any of the above are possible.

E) none of the above

4. When a good has a unitary price elasticity, consumer expenditures for the good

A) change in the same direction as a price change.

B) change in the opposite direction to a price change, but not necessarily by the same percentage as the price change.

C) do not change when the price of the good decreases.

D) change in the opposite direction and by the same percentage as any price change.

5. Which of the following is true concerning the substitution effect of a decrease in price?

A) It will lead to an increase in consumption only for a normal good.

B) It always will lead to an increase in consumption.

C) It will lead to an increase in consumption only for an inferior good.

D) It will lead to an increase in consumption only for a Giffen good.

Short Answers

1. Suppose you derive utility from Food (F) and Clothing (C). Your preference exhibits diminishing MRS between F and C.  Let’s put F on the Horizontal axis and C on the vertical axis.

(2 points for each part)

a. If price of Food increases, show the IE and SE on a separate diagram if F is a normal good.

b. If price of Food increases, show the IE and SE on a separate diagram if F is an inferior good.

c. If price of Food increases, show the IE and SE on a separate diagram if F is a Giffen  good.

d. If price of Food decreases, show the IE and SE on a separate diagram if F is a normal good.

e. If price of Food decreases, show the IE and SE on a separate diagram if F is an inferior good.

f. If price of Food decreases, show the IE and SE on a separate diagram if F is a Giffen  good.

2. Suppose two goods X and Y are perfect complements. (2 points for each part)

a. If price of X increases, show the IE and SE.

b. If price of X decreases, show the IE and SE.

c. Is X a normal good, inferior good, or Giffen good. Why? What about Y?

3. (Bonus) Suppose two goods X and Y are perfect substitutes. You have $100 to spend between these two goods. The price of X is $1 and the price of Y is $1. The MRSx,y=2.

(2 points for each part)

a. Show the BL1 and IC (label this U1) on a diagram. How much X and Y do you consume to maximize your utility? Label this point A.

b. Using the same diagram, show the IE and SE if price of X is $1.5.

c. Using the same diagram, show the IE and SE if price of X is $3.

Answer 1

1. C) Utility is maximized, and all income is spent.

Explanation: In simple words, PCC indicates the various amounts of a commodity bought by a consumer to maximize utility when the price changes.