Name:___________________________

SID:__________________________

GSI name: ______________________ Section #:__________________________

ECON 100A FALL 2012 MIDTERM I

Instructions
BREATHE! This exam starts at 4:10 pm and ends precisely at 5:30 pm. No extensions will be granted. Before you hand in the exam, make sure your name AND SID are at the top of the page, as well as your GSIs name. By taking this exam, you acknowledge that the use of outside materials is not permitted. Anyone caught using outside material, including your neighbors exam, will get 0 points on the exam. Before you start working, read the questions carefully. If you have any questions, ask!

GOOD LUCK!

PART I Mark whether the following statements are true or false. No explanation needed.

1. If cereal and milk are perfect complements and the price of milk decreases, the substitution effect is smaller than the income effect.

TRUE

FALSE

2. George will buy Bananas only when they cost $1 a pound. His demand for Bananas is

inelastic. TRUE FALSE

3. If price elasticity of demand is negative then the good must be normal.

TRUE

FALSE

4. Consumer surplus is a cardinal measure.

TRUE

FALSE

5. Tom and Jeri both love cheese, but Jeris demand for cheese is more elastic. For a given market price, Jeris consumer surplus is higher than Toms.

TRUE

FALSE

No points should be deducted

6. The compensated demand curve is more elastic than the uncompensated demand curve when a good is normal.

TRUE

FALSE

7. An increase in income will shift the Engel curve to the right.

TRUE

FALSE

8. If cross-price elasticity of two goods is +1%, then the goods are neither complements nor substitutes.

TRUE

FALSE

9. The slope of the indifference curve tells us how much money we need to forgo in order to buy one more unit of good X.

TRUE

FALSE

10. Daniel consumes pizza (x-axis) and sushi (y-axis). The price of pizza is $3 a slice and the price of a sushi is $6. The MRS at Daniels current consumption bundle is 1/3. To maximize utility Daniel should consume less sushi and more pizza.

TRUE

FALSE

This question was mis-graded. Please get the professor to change your grade if you put false and got points off for that.

PART II SHORT ANSWER QUESTIONS 1. Harold regards pizza (x-axis) and burgers (y-axis) as imperfect substitutes. The price of burgers decreases and Harold consumes the same amount of pizza. a. Graph this scenario and mark the price-consumption curve on your graph. b. Can U = X2Y be a utility function representative of these preferences? Show with math why or why not. Burgers Price consumption curve

Pizza

For part b, you had to find the demand for good y and see whether px was in that expression. If so, then clearly it cannot be represented by these preferences. MUx/MUy = 2XY/X2 = Px/Py 2PyY = PxX 2PyY = M PyY -> Y = M/3Py Since the demand for Y does not include the price of good X, then this potentially could be a representation of the preferences above.

2. For a price increase of good X, draw X as an inferior good. Be sure to mark your income and substitution effects clearly on your graph.

3. Trace the demand curve for a Giffen good by using the 2-panel graph I showed in class: on the top panel find two optimal bundles for different prices. On the bottom panel, plot the corresponding demand curve. Make sure your axis are labeled.

4. Define the term transitivity. Give an example of non-transitive preferences and explain how this could be a problem.

If A is preferred to B and B is preferred to C then A is preferred to C. Example of non-transitive preferences: Joseph prefers Heineken to Guinness and Guinness to Leffe, but when offered the choice between Heineken and Leffe, he chooses Leffe. Such preferences mean that

Long-Answer Question 1. James, Pierres twin, consumes coffee and cigarettes, which he regards as imperfect substitutes. One day he wakes up to the terrible news that the government imposed a 200% tax on cigarettes and that drought conditions in South America lead to the price of his favorite coffee to double. a. Draw James initial consumption bundle, and his budget constraint after the price changes. You may choose the axis. What you had to figure out here is that a 200% tax increase triples the cost of cigarettes, while the price of coffee doubles.

b. James parents hear about his hardships and decide to increase his stipend so he can purchase the same bundle he purchased before. Add this budget constraint to your graph. c. Given the new prices and his additional stipend, will James consume more or less coffee than his initial bundle? (HINT: he has to maximize utility) A original B.C. B B.C. after the price change C - B.C. after parents compensation. This B.C. crosses through the original bundle, but since its flatter it has to be above the original B.C. on the right. This means that James will consume more coffee and less cigarettes.

d. Pierre complains to his parents that the stipend they gave James is too high and claims that if they gave him a Hicksian compensation they will save money AND James will also smoke less than he did before the price changes. Is the Hicksian compensation going to save money to James and Pierres parents? Is James going to smo ke less that he did before the price changes? Explain your answer. In blue I marked the Hicksian compensation allocation where utility is the same as the original bundle. Pierre is right that his parents will save money if they use this compensation since Hicksian compensation is always less than Slutsky. Relative to the original bundle, James will consume less cigarettes and more coffee. But it will be more cigarettes and less coffee relative to the Slutsky compensation. NOTE: The answers are the same, even if you put coffee on the y-axis the graph will look different, but the answers will be the same.