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2 a. Using the above information to calculate the cost of the market basket for each of the years and present your calculations in the table below: 2014 Cost of Market Basket b. Let 2014 be the base year, calculate the CPI for each year using a 100-point scale. Then, for to, calculate the annual inflation rate. Calculate your answers to two places past the decimal. CPI Inflation Rate c is still the base year. Calculate the real price of pizza in each year. Again, calculate your answers to two places past the decimal Real price of pizza 2

3 Part II: Elasticity 2) This set of questions focuses on elasticity. a. Suppose Howard s demand for hamburgers decreases from 8 hamburgers to 5 hamburgers when the price increases from \$4 per hamburger to \$6 per hamburger. What is his price elasticity of demand for hamburgers? Use the standard formula for the percentage change to calculate this value. b. Although the price of a hamburger remains at \$6 per hamburger, Howard s demand for hamburgers increases from 5 hamburgers to 8 hamburgers when his hourly wage rises from \$20 to \$36. What is his income elasticity of demand for hamburgers? Use the standard formula for the percentage change to calculate this income elasticity. Are hamburgers normal or inferior goods for Howard? c. John, a seller of hamburgers, sells hamburgers to Howard for \$6 per hamburger. John has observed that Howard s demand for hamburgers decreases from 8 hamburgers to 5 hamburgers when the price of sandwiches decreases from \$5 per sandwich to \$4 per sandwich. What is his cross-price elasticity of hamburgers for sandwiches? Use the arc elasticity formula concept when calculating this cross-price elasticity. Based upon your value for the cross-price elasticity of demand of hamburgers for sandwiches, are these two goods substitutes or complements? Explain your answer. d. Suppose at \$6 per hamburger, John can supply an infinite quantity of hamburgers but he will supply none at a price below \$6. What do you know about his supply when price rises above \$6? What is John s price elasticity of supply? e. When the price of hamburgers is \$8 per hamburger, John can sell 45 hamburgers in a day. We know when the price of hamburgers decreases to \$6 per hamburger, John s total revenue remains unchanged. Given this information and assuming that John s demand curve for hamburgers is linear, what do we know about the price elasticity of demand for his hamburgers? Use the standard formula for the percentage change to calculate this elasticity value. Given this information write an equation for this demand curve in slope-intercept form. Once you find the demand curve provide an explanation for why John s total revenue is not changing as the price of hamburgers falls from \$8 per hamburger to \$6 per hamburger. 3

5 4) With the same information as above, a Wisconsin resident Alice only consumes two goods: bread (B) and rice (R). Her budget constraint and utility are given by the formula: Y= P B B + P R R U= BR Given her current consumption bundle (B, R), her marginal utility from consuming bread is given by MU B = R and her marginal utility from consuming rice is given by MU R = B. a. Suppose Alice s income is Y=\$40, and the prices for bread and rice are P B = \$4, P R = \$1. What is her optimal consumption bundle? (You have to derive it instead of using the result of Question 3(a)). What is the value of Alice s utility at this consumer optimization point? Show how you found this value. b. Fill out all the missing information in the table Quantity of Bread Quantity of Rice Utility c. Graph the optimal consumption bundle in (a), with bread on the horizontal axis and rice on the vertical axis. Also graph the indifference curve, IC1, for U = 100 using the values you found in part (b). d. Draw the indifference curve, IC2, for U = 400 in this same graph. You might find it helpful to construct a similar table to part (b) with U = 400. e. Now suppose the price level is P B = 1, P R = 1 and Alice s income is now equal to \$20. Suppose Alice wants to achieve a utility level of U=100. Given this information and holding everything else constant, what should be her optimal consumption bundle? 5

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