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YEDITEPE UNIVERSITY

ECON-502: Take-Home
Exam
Instructed by: Kemal Kasaroğlu

Burcu OSKAR
29/03/2011

                         
  q1 q2 U1 U2 MU1 MU2 MU1/P1 MU2/P2     P1= 17  
  0,0 0,0 0 0 0 0 0 0     P2= 34  
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  1,0 1,0 80 336 80 336 4,706 9,882          
  1,5 1,5 156 640 76 304 4,471 8,941          
  2,0 2,0 228 872 72 232 4,235 6,824          
  2,5 2,5 288 1040 60 168 3,529 4,941          
  3,0 3,0 344 1184 56 144 3,294 4,235          
  3,5 3,5 384 1320 40 136 2,353 4,000          
  4,0 4,0 416 1432 32 112 1,882 3,294          
  4,5 4,5 436 1498 20 66 1,176 1,941          
  5,0 5,0 448 1528 12 30 0,706 0,882          
  5,5 5,5 456 1544 8 16 0,471 0,471          
  6,0 6,0 462 1552 6 8 0,353 0,235          
  6,5 6,5 466 1552 4 0 0,235 0,000          
  7,0 7,0 468 1544 2 -8 0,118 -0,235          

                           
Question 1.

a-) P2=34 and P1=17, levels of income the consumer would be in equilibrium to maximize utility

Budget constraint: y= P1*q1 + P2*q2

y1=17*2 + 34*3= 136 TU1= U1+U2= 228+1184= 1412

y2=17*3 + 34*4= 187 TU2= U1+U2= 344+1432= 1776

y3=17*5,5 + 34*5,5= 280,5 TU3= U1+U2= 456+1544= 2000

y4=17*6,5+ 34*6=314,5 TU4= U1+U2= 456+1552= 2008

The Consumer is said to be in Equilibrium when s/he obtains the maximum possible satisfaction from the
purchases, given the income of consumer and prices of goods in the market. In Consumer Equilibrium we
are normalizing the change in utility by the price of the good and then equating it to the normalized
marginal utility of the other good.( MU1/P1 = MU2/P2 ) In these conditions I found 4 of them from the
table. After that, I wrote budget equations and calculated the Total Utility values.

b-)
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y1= 136 q1= 0 q2= 4 y2= 187 q1= 0 q2= 5,5
q2= 0 q1= 8 q2= 0 q1= 11

y3= 280,5 q1= 0 q2= 8,25 y4= 314,5 q1= 0 q2= 9,25
q2= 0 q1= 16,5 q2= 0 q1= 18,5

In the following graph, I draw four budget constraint lines which I found in section (a) and then marked the
consumption quantities of good 1 and good 2 for all these equations. Finally I draw the indifference curves
which are tangent to the E1, E2, E3 and E4 points.

c-) I assume that income level y= 280,5 and P1 increased to 40.

y = P1 * q1 + P2 * q2 q1’ = 11
............280,5 = 8,5 * q1’ + 34 * 5,5
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d-) Income & substitution effects ( P1’= 40, y= 280,5 )

e-) arc elasticity of P1 between P1’=17 and P1”= 19

EP1’ = (q1” - q1’) / 0,5* (q1” + q2’)

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(P1” – P1’) /0,5* (P1” + P1’) EP1’ = (4,92 – 5,5) / 0,5* (4,92 + 5,5)

For P1’ , q1’= 5,5 for P1” , q1”= 4,92 (19- 17) /0,5 * (19 + 17)

= -1,001918 ( EP1’< 0 )

Question 2.

a-) ceteris paribus assumption ; all other variable remains same.

I assume that Y=250, P2= 50 and P1= 10

q1= 50 – 5* 10 + 0,5* 50 + 0,4* 250 = 125

For P1’= 20

q1= 50 – 5*20 + 0,5* 50 + 0,4* 250 = 75

b-)
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Ep = (dq / dp)*( P1/q1)

In our demand curve for good1, q1= 175 – 5*P1

Demand curve slope (dq / dp)= -5

 P= 0 q= 175- 5*0= 175 Ep= -5 * (0/175) = 0

 P=35 q= 175- 5*35 =0 Ep= -5* (35/0)= -∞

 At P= 17,5 and q= 87,5 l Ep l = -5* (17,5 / 87,5) = 1

c-) Two different levels of prices

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Question 3.

It is important to know the extent to which percentage increase in unit price will affect the demand for a
product. With elastic demand, total revenue will decrease if the price is raised. With inelastic demand, total
revenue will increase if the price is raised. It is important to note that an entire demand curve is elastic or
inelastic; it only has the particular condition for a change in total revenue between two points on curve. It is
important to understand the demand elasticity of their products and services in order to set prices to
maximize firm profits and revenues.

Question 4.

Command economy:

Pros:
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- capable of rapid change for major problems
- class system does not develop all people are effectively equal

- command economies are very stable and will never have sudden depressions.

Cons:

- little focus on consumer wants

- little innovation and goods are often poor quality and there is usually limited choice

Market economy:

Pros:

- economic growth by providing an open competition in the market

- raising income and achieving economic growth

- price flexibility (avoid tremendous profit loss when no longer in high demand)

- decentralized economic system

- the monetary value of any good is determined by the supply and demand of that good

Cons:

- doesn’t always provide the basic needs in the society.

- rich get richer while the poor get poorer
- due to price mechanism, economic instabilities cannot be controlled through changing interest rates,
as the government does not intervene in free market economies

Mixed economy:

Pros:

- increase in overall production and efficiency

- flexibility to intervene in the economy in times of emergency
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Cons:

- Production may not keep up with supply and demand (create surplus, or deficiency of goods or
services, contributes to loss revenue/profits)