ECON 3710, Intermediate Microeconomics Exam #1 Spring, 2008

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1 ECON 3710, Intermediate Microeconomics Dr. Tod Porter Exam #1 Spring, 2008 Last Name First Name 1. (30 pts.) Put an "X" directly over the "T" if the statement is true, or an "X" over the "F" if it is false. T F Sunk costs can be changed at any point in time. T F A positive question is a question about the consequences of specific policies or institutional arrangements. T F The horizontal view of the demand curve tells us the value consumers place on the last unit of the good purchased. T F In a competitive market, the quantity where quantity demanded equals the quantity supplied is also the same quantity where the marginal benefit of the last unit equals the marginal cost of the last unit. T F An inferior good is a good consumers purchase fewer units of when their income rises. T F Two goods are considered complements if one of the goods can be easily substituted for the other good. T F The law of supply is the empirical observation that when the price of a product rises firms offer more of it for sale. T F If A is preferred to B, and B is preferred to C, and C is preferred to A we would say the consumer s preferences are transitive. T F Indifference curves further away from the origin are associated with higher levels of utility. T F If two goods are perfect complements the indifference curve map for those two goods will consist of straight lines. T F Indifference curves will slope downward because we assume that having more of a good makes a consumer better off. T F A corner solution is a situation where the consumer maximizes their utility by spending all of their income on one good. T F At a point on the elastic portion of the demand curve an increase in price will result in an increase in total expenditures. T F If the income elasticity of a good is 2, that implies that a 10 percent increase in income will result in a 20 percent increase in the quantity purchased. T F If the cross-price elasticity of X and Z is positive [(Qx/Pz)( Qx/ Pz)>0] then X and Z are substitutes.

2 2. (9 pts.) Assume that the demand for a good can be represented by the function P = 100 Qd (or alternatively Qd = 100 P). The supply for the good can be represented by the function P = 3Qs (or Qs = P/3). a. (4) Find the equilibrium price and quantity. b. (2) If a price ceiling of $10 is imposed, will there be a shortage or surplus (show mathematically)? c. (3) What is the size of the deadweight loss created by the price ceiling? 3. (8 pts.) The graphs below show the market for ice cream. In each case, draw a new demand curve or a new supply curve to represent the change in the market. Indicate if there was a change in demand or a change in the quantity demanded. The price of milk rises: P D S Ice cream is shown to lower one s blood pressure P D S Q Was there a: Change in demand Change in quantity demanded Change in demand Change in quantity demanded Q

3 4. (8 pts.) Assume an individual has an income of $150, the price of X is $3 and the price of Y is $5. Draw the individual s budget line below. Indicate the values of the X and Y intercepts and the slope of the budget line. Assume the consumer receives a gift of 10 units of X. Redraw the budget line and again indicate the values of the X and Y intercepts and the slope. Y X What is the opportunity cost of one unit of X? 5. (5 pts.) Define the term marginal rate of substitution. 6. (5 pts.) Assume that the consumer has equally divided his spending between X and Y. At that combination of X and Y the marginal rate of substitution equals 10 and Px/Py equals 6. Should the consumer change his or her purchases? Explain your answer. 7. (5 pts.) Define the term substitution effect.

4 8. (8 pts.) Assume that the consumer s utility function is U = X 1/2 Y, and the consumer will seek to maximize: L = X 1/2 Y (PxX +PyY M) a. (4) Take the partial derivative of L with respect to X, then do the same for Y. b. (2) Using the ratio of the two partial derivatives, find the condition for utility maximization. c. (2) If the consumer is consuming 5 units of X, 10 units of Y, Px equals $4, and Py equals $4, is the individual maximizing their utility? Justify your answer. 9. (8 pts.) On the graph below, break down the change resulting from the increase in the price of X into income and substitution effects. Y B2 B1 X Is X a normal or inferior good?

5 10. (8 pts.) List two determinants of the elasticity of demand and explain how they would either make demand more elastic or more inelastic. 11. (6 pts.) The demand for a good can be represented by the function Qd = 100 4P. a. (3) What is the price elasticity of demand if the price of the good is equal to 10? b. (3) At what price and quantity will total expenditure be maximized?

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