Econ 10 a midterm 2 multiple choice Qs

If the nominal interest rate is 200% annually and the inflation rate is 50% annually, then what is the exact realinterest rate? (a) 100% (b) 150% (c) 200% (d) 250% (e) 350%

(1 + real rate) * (1 + inflation rate) = (1 + nominal rate) -> (1 + real rate ) * (1 + .5) = 1 + 2 real rate = 1 = 100%

A museum is currently selling 10 original famous paintings for $1 million each. Only these 10 paintings are for sale,and there are no copies of these paintings that exist anywhere in the world. Suppose the government imposes a tax of$10,000 per painting on the buyers. What is the resulting deadweight loss? (a) $0 (b) $1,000 (c) $10,000 (d) $100,000 (e) $1,000,000

(a) $0 Since there is a fixed supply of 10 paintings, supply is perfectly inelastic. Therefore the resulting deadweight loss is $0, since there is no wedge induced between supply and demand

Marquesa earns money and can spend money only this year and next year. Her utility is𝑈(𝑐1, 𝑐2) = 𝑐1𝑐2. She can save and borrow as much as she wants at an annual interest rate of10%. If she earns $50,000 this year and $110,000 next year, what is the largest amount shecould consume next year? (a) $165,000 (b) $150,000 (c) $110,000 (d) $82,500 (e) None of the above

(a) $165,000 Future Value= 50,000*(1.1) +110,000=55,000 +110,000=165,000.

Farmer Steve produces milk in any quantity that he wants (including fractional amounts ingallons). Suppose that the supply for milk is given by S(p) = p - 2, with quantities in gallons andprices in dollars. What is the gain in producer surplus if the price of milk increases from $6 pergallon to $7 per gallon? (a) $4.50 (b) $3.50 (c) $2.50 (d) $1.50 (e) None of the above

(a) $4.50

Joe Wolfman has just received a job at a local radio station and he is trying to determine how many hours to work.He can work as many hours as he wants at a wage rage of $60 per hour, and he has 100 hours available per week forlabor and recreation. We know the following about Joe: His marginal rate of substitution for recreation/consumption (as defined in class) is always -50. He receives a non-labor payment from his ex-wife every week of $900. Consumption and recreation are both goods. He will choose the number of hours of work per week that will maximize his utility. His price for consumption is unity. How many hours will Joe work per week? (a) 100 (b) More than 50 but less than 100 (c) 50 (d) More than 0 but less than 50 (e) 0

(a) 100

For the demand function D(𝑝) = 900 − 9p, for what price is price elasticity equal to 1 (in absolutevalue)? (Note that price elasticity is sometimes called own price elasticity.) (a) 100 (b) 50 (c) 12.5 (d) 5 (e) None of the above

(b) 50 Two ways of solving .1) From "Market Demand" slides, we know where the point is the elasticity = 1.For linear demand curve D(p) = a - bp, the elasticity equals 1 where p = a/(2b) = 900/18 = 50 2) Use the formula: ε = 𝐷 ′(𝑝) ⋅ 𝑝/𝐷(𝑝) and note that the absolute value is equal to 1.|𝐷 ′(𝑝) ⋅ 𝑝/𝐷(𝑝)| = | − 9 ⋅ (p/900 − 9p)| = 1 and then solving for where the inside of the absolute valueequals -1 gives the solution of p = 50

ssume that Hayden receives an endowment of 6 apples and 8 oranges. The price of applesis $2 each and the price of oranges is $1 each. Both commodities are goods. If Hayden has one-for-one perfect substitute preferences (e.g. her utility never changes when she simultaneouslygives up one apple and gets an additional orange), how many oranges will she consume inorder to maximize utility? (a) 20 (b) 14 (c) 12 (d) 10 (e) None of the above

(a) 20 The value of her endowment is 2*6+1*8=20 dollars. Since she has perfect substitute utility, shewill either consume all apples or all oranges for her optimal bundle. Let's compare the MRS tothe price ratio to figure out the optimal bundle. The MRS=1 since we know she has one-for-oneperfect substitute preferences. The price ratio is 2 based on the prices given. Thus, since theprice ratio is larger than the MRS, Hayden will choose to consume only good 2 (oranges). Sincethe value of her endowment is $20 and each orange costs $1, the optimal bundle is (0,20).

Suppose that the price of hamburgers increases at the rate of inflation each year. The priceof a hamburger this year is $6. Javier has $60 currently available. If he puts the money into abank account that earns 5% over the next year, how many hamburgers can he buy after 1 yearif the annual inflation rate is always 50%? (a) 7 (b) 8 (c) 9 (d) 10 (e) None of the above

(a) 7 The price of hamburgers next year will be 𝑝𝐻 = 6(1.5) = 9 since prices inflate at a rate of 50%.The amount of money he will have next year is 𝑚 = 60(1.05) = 63 since the interest rate is 5%.Thus, the number of hamburgers he can buy is 63/9 = 7 hamburgers.

Janel's utility function for two commodities is given by 𝑈(𝑥1, 𝑥2) = min(𝑥1, 2𝑥2). Shecurrently has $60 to spend, and the price of each commodity is $1. When the price of commodity 1 (x1) increases from $1 to $2, what can be concluded about the change in quantity of commodity 1 due to the substitution effect (SE) and income effect (IE)? (a) SE is 0 and IE is negative (b) SE is negative and IE is 0 (c) SE is negative and IE is positive (d) SE is negative and IE is negative (e) None of the above

(a) SE is 0 and IE is negative When the price goes up, we know our final bundle will contain less of good 1 and good 2 relativeto our original bundle since we are dealing with perfect complements. Additionally, thesubstitution effect for perfect complements is zero since the compensated budget line shouldalso hit at the corner of the IC that the original bundle is on. Thus, when the TE is negative, we can attribute that to a SE=0 and a negative IE.

Ludwig's utility function is U(x,y)=3x+y. Initially, Ludwig has $18 to spend on goods, the price of good x is $3 per unit, and the price of good y is $2 per unit. When the price of good x increases to $9 per unit, which of the followingstatements is true? (SE = substitution effect, IE = income effect) (a) The change in quantity demand for good x due to the SE is -6 (b) The change in quantity demand for good x due to the SE is 0 (c) The change in quantity demand for good x due to the IE is -3 (d) The change in quantity demand for good y due to the IE is 9 (e) None of the above

(a) The change in quantity demand for good x due to the SE is -6

Which of the following is implied by risk-loving behavior? (a) The first derivative of utility is positive and the second derivative is positive (b) The first derivative of utility is negative and the second derivative is positive (c) The first derivative of utility is positive and the second derivative is zero (d) The first derivative of utility is positive and the second derivative is negative (e) None of the above is implied by risk-loving behavi

(a) The first derivative of utility is positive and the second derivative is positive

A security that has a present value of $Y makes one payment 6 years from now. This is the security's only payment.How much must this payment be? Assume an annual interest rate of r. (a) Y / (1 + r)^6 (b) 𝑌/(1+𝑟)^6 (c) 𝑌/(1+𝑟) (d) Y (1 + r) (e) None of the above

(a) Y / (1 + r)^6 Solve for X in the following equation: X/(1+r)6 = Y -> X = Y(1+r)^6

For this question, assume that indifference curves are strictly convex, consumption andleisure are normal goods, and the optimal amounts of consumption, leisure, and labor arealways positive. A wage increase ______. (SE = substitution effect; IE = income effect) (a) increases labor supply via the SE and decreases labor supply via the IE (b) decreases labor supply via the SE and decreases labor supply via the IE (c) increases labor supply via the SE and increases labor supply via the IE (d) decreases labor supply via the SE and increases labor supply via the IE (e) Can't tell without knowing the utility function

(a) increases labor supply via the SE and decreases labor supply via the IE Wages are the price of leisure, so when wages go up leisure goes down and laborsupply goes up via the SE. As wages increase so does your overall income, leisureis a normal good and increases with income so labor supply decreases via the IE.

Farmer Joe produces milk in any quantity that he wants (including fractional amounts in gallons). Suppose that thesupply for milk is given by S(p) = p - 1, with quantities in gallons and prices in dollars. What is the gain in producersurplus if the price of milk increases from $3 per gallon to $4 per gallon? (a) $3.50 (b) $2.50 (c) $2 (d) $0.50 (e) None of the above

(b) $2.50

Suppose that the demand function for a good is D(𝑝) = 100 − p, the supply function is S(𝑝) = p,and a tax of $10 per unit is imposed on sellers for each unit of the good sold. How much is thedeadweight loss due to the tax? (a) $10 (b) $25 (c) $50 (d) $100 (e) None of the above

(b) $25

Clarabelle will receive three payments of $450. The first payment will occur later today, the second payment in oneyear, and the final payment in two years. Her annual interest rate is 50%. What is the combined present value of thethree payments? (a) $1,350 (b) $950 (c) $900 (d) $675 (e) None of the above

(b) $950

Steven has non-labor income each week of $1,200. He can work up to 90 hours per week foran hourly wage of $20 per hour. His utility for recreation (R) and consumption (C) is given by𝑈(𝑅, 𝐶) = 𝑅𝐶^2. How many hours will Steven work per week if he is maximizing his weeklyutility? Assume the price of consumption is unity. (a) 30 (b) 40 (c) 50 (d) 60 (e) None of the above

(b) 40

Suppose there are two goods, apricots and beans. What is the definition of the net demand forbean consumption? (a) Amount of beans harvested minus amount of beans consumed (b) Amount of beans consumed minus amount of beans harvested (c) Amount of beans consumed minus amount of apricots harvested (d) Amount of apricots harvested minus amount of beans consumed (e) None of the above

(b) Amount of beans consumed minus amount of beans harvested Verbal description of mathematical definition in "Buying and Selling" slides

Tom maximizes his utility by choosing between consumption today and consumption tomorrow. Consumption todayand consumption tomorrow are both normal goods. He has well‐behaved indifference curves, positive income in bothperiods, and there is no inflation. Suppose the interest rate increases, and Tom's consumption today increases as aresult. Which of the following must be true about Tom?(a) He is a borrower today (b) He is a lender today (c) His consumption today is always higher than his consumption tomorrow (d) The income effect and the substitution effect go in the same direction for his consumption today (e) None of the above

(b) He is a lender today

Assume that the market for pencils is always in equilibrium, has a perfectly inelastic supply curve and a demandcurve with constant slope of -5. If the demand curve shifts to the right, what happens to the price and quantity ofpencils? (a) Both price and quantity increase (b) Price increases but quantity remains constant (c) Price remains constant but quantity decreases (d) Both price and quantity decrease (e) None of the above

(b) Price increases but quantity remains constant

If someone maximizes utility by choosing the no-insurance point, which of the followingmust be true? Assume that the cost of insurance is less than the fair price. (a) The person is risk averse (b) The person is risk loving (c) The person has linear indifference curves (d) The person consumes equal amounts in all states (e) None of the above

(b) The person is risk loving When insurance is fair, risk averse person chooses full insurance, risk neutral person is indifferentbetween full and no insurance, and risk loving person chooses no insurance. With the cost ofinsurance less than the fair price, individuals become more likely to purchase insurance than whenthe insurance was fair (each unit of insurance is cheaper, so they buy more of it). This means thatrisk averse person continues to choose full insurance and risk neutral person now chooses fullinsurance. Therefore, someone who chooses no-insurance point with insurance cheaper than thefair insurance is risk loving

Tom is trying to decide how much to consume during the next two periods: (𝑐1, 𝑐2). He gets $4000 inperiod 1 and $3000 in period 2. He has the option of borrowing or lending at an interest rate of 50%. If Tom'sutility function is 𝑈(𝑐1, 𝑐2) = 𝑐1𝑐2, what level of consumption does he choose in period 1 (𝑐1) if there is noinflation? (a) $2000 (b) $2500 (c) $3000 (d) $4000 (e) None of the above

(c) $3000

A bond pays $1,000 each year for 3 years, starting in 1 year. It pays its face value $F 3 years from today. The presentvalue of this bond is $975. If the interest rate is 100%, what is F? (a) $12.50 (b) $14,800 (c) $800 (d) $232 (e) $500

(c) $800 PV=1000/2+1000/2^2+ (1000+$F)/2^3=$500+250+ (1000+$F)/8=$975 (1000+$F)/8=$225 $1000 + $F= $1800 $F=$800

(5) For the demand function D(𝑝) = 100 − 2p, for what price is price elasticity equal to 1 (inabsolute value)? (Note that price elasticity is sometimes called own price elasticity.) (a) 100 (b) 50 (c) 25 (d) 5 (e) None of the above

(c) 25 Two ways of solving .1) From "Market Demand" slides, we know where the point is the elasticity = 1. For linear demand curve D(p) = a - bp, the elasticity equals 1 where p = 100/(2b) = 100/4 = 25 2) Use the formula: ε = 𝐷'(𝑝) ⋅ 𝑝/𝐷(𝑝) and note that the absolute value is equal to 1.|𝐷 ! (𝑝) ⋅ 𝑝/𝐷(𝑝)| = | − 2p/(100 − 2p)| = 1 and then solving for where the inside of the absolutevalue equals 1 gives the solution of p = 25.

Elizabeth's utility is represented by the square of her consumption in dollars, U(x) = x 2. She has positive income of mdollars. But, with probability π (0< π<1), she will lose L dollars, where 0< L<m. She has the option to buy K dollars ofaccident insurance, where each $1 of insurance costs γ. Suppose further that the insurance is fair, i.e., γ= π. If Elizabethis maximizing her utility, which of the following is true about her optimal insurance choice, K? (a) K = L (b) 0 < K < L (c) K = 0 (d) K > L (e) K = m

(c) K = 0 Since Elizabeth is risk loving she will not buy any insurance under fair insurance.

Lila will receive income of $1,000 this week, and she cannot save or borrow. Her utility function as a function ofconsumption is U(c) = ln(c). She may get sick this week, which would lead to a $400 loss. Her probability of getting sick is30%. The Cold July Day Company offers Lila insurance that has a cost of 30 cents for each dollar she purchases, but onlyallows her to purchase a non-negative amount of insurance up to $300. No other insurance can be purchased by Lila.Which of the following is true when Lila maximizes her expected utility? Assume that getting sick is the "bad" state andnot getting sick is the "good" state. (a) Lila will definitely consume more in the bad state than in the good state. (b) Lila will definitely have equal amounts of consumption in both states. (c) Lila will definitely consume less in the bad state than in the good state.(d) There is not enough information to determine how much Li

(c) Lila will definitely consume less in the bad state than in the good st

Harrold receives $50,000 in period 1 and $60,000 in period 2 with certainty. His utility function over period 1 and period 2 consumption is given by 𝑈(𝑐1, 𝑐2) = 𝑐1^1/2 𝑐2^3/2. Suppose the nominal interest rateis 50% (0.5) and the inflation rate is 50% (0.5). What choice is consistent with Harrold's utility-maximizing consumption level in period 1? (a) Borrow $25,000 (b) Borrow $5,000 (c) Save $22,500 (d) Save $25,000 (e) None of the above

(c) Save $22,500 To derive the intertemporal budget constraint, first note that the real interest rate (nominal interestrate minus inflation rate) = 0. Harrold's lifetime wealth is $110,000. Since he has Cobb-Douglaspreferences, his demand function for consumption in period 1 is 𝑐1∗ = 0.25 × 110,000 = 27,500. Withan income of $50,000, this means Harrold saves $22,500 in period 1, making (c) the correct answer. Thematerial for this is in Lectures 12 and 13

f the annual inflation rate is 10% and the annual real interest rate is 20%, what is the annualnominal interest rate?(a) Less than 0% (b) Between 5-15% (c) 30% (d) More than 30% (e) None of the above

(d) More than 30% (𝟏 + 𝝅)(𝟏 + 𝝆) = 𝟏 + 𝒓 (𝟏. 𝟏)(𝟏. 𝟐) = 𝟏 + 𝒓 𝟏. 𝟑𝟐 = 𝟏 + 𝒓 𝒓 = 𝟎. 𝟑𝟐 = 𝟑𝟐%

Soriana grows cherries (x1) and corn (x2). This year, she grows 5 pounds of cherries and 10 pounds of corn. She canbuy and sell as many cherries as she wants for $10 per pound, and as much corn as she wants for $5 per pound. Herutility function is 𝑈(𝑥1, 𝑥2) = 2𝑥12 + 𝑥22. Which of the following statements is true? (a) Soriana will neither buy nor sell either commodity if she maximizes her utility. (b) Soriana will be indifferent between the consumption points (10, 0) and (0, 20). (c) Soriana will consume no cherries at her utility maximizing point. (d) Soriana will sell some of her corn (but not all of it) at her utility maximizing point. (e) None of the above

(c) Soriana will consume no cherries at her utility maximizing point.

Kristopher has risk-neutral preferences. Which of the following statements is correct? (a) The first derivative of his utility function is negative and the second derivative is positive (b) The first derivative of his utility function is positive and the second derivative is negative (c) The first derivative of his utility function is positive and the second derivative is zero (d) The first derivative of his utility function is positive and the second derivative is positive (e) None of the above

(c) The first derivative of his utility function is positive and the second derivative is zero

What is always held constant when calculating the Hicks substitution effect? (a) Quantity consumed of both goods (b) Quantity consumed of exactly one good (c) Utility (d) The slope of the budget constraint (e) None of the above

(c) Utility By definition, utility is always held constant when calculating the Hicks

For a given individual, the weighted average of _______ elasticities equals 1. (Note: If own-price, cross-price, andincome are all correct, pick "all.")(a) own-price (b) cross-price (c) income (d) all (e) None of the above

(c) income By definition, elasticity is the ratio between percentage change in demand and percentage change in price or income.Weighted average of elasticities equal to 1 implies that given one percent change in income or price, demand mustalso increase by 1 percent on average. Clearly, this does not have to be true for price elasticities. If price of goods xand y both increase by 1 percent, overall demand for x and y doesn't have to change by 1 percent. It could, forexample, be that 1 percent increase in price of x decreases demand for x by 2 percent while increasing demand for yand 1 percent increase in price of y decreases demand for y by 2 percent while increasing demand for x. In otherwords, change in x and y for change in their own price does not have to balance out. For income, however, it needs tobalance out because 1 percent change in income should translate into 1 percent change in consumption overall.Otherwise, some of the additional income is left unused and the consumption is unlikely to be optimal (take a look atslide 24 of lecture notes on Market Demand for mathematical explanation). → (c) is the correct answer.

If you are risk-loving and the price of insurance is exactly fair, how much insurance wouldyou purchase? (a) Full insurance (b) Less than full insurance but more than no insurance (c) No insurance (d) More than full insurance (e) None of the above

(c) no insurance Risk loving individuals would not purchase insurance if its price is exactly fair, they may purchase some if it's more than fair (and that would depend on their preferences).

A price ceiling set below the equilibrium price ______. (a) always increases consumer surplus and generates no loss to society (b) always reduces producer surplus and always increases consumer surplus (c) will sometimes increase consumer surplus, while in other cases will decrease it (d) will sometimes increase producer surplus, while in other cases will decrease it (e) always reduces both consumer and supplier surpluses

(c) will sometimes increase consumer surplus, while in other cases will decrease it B-A could be positive or negative, B+C is always positive.

Which of the following functions is consistent with a person who is risk neutral? (a) 𝑈(𝑐) = 𝑐^2 (b) 𝑈(𝑐) = √𝑐 (c) 𝑼(𝒄) = 𝟕𝟓𝒄 − 𝟏𝟎𝟎 (d) 𝑈(𝑐) = 𝑐2 − √𝑐 (e) None of the above

(c) 𝑼(𝒄) = 𝟕𝟓𝒄 − 𝟏𝟎𝟎 (A person is risk neutral if 𝑼′′(𝒄) = 𝟎. Another way to say this is that the utility is a linear function of consumption,because second derivative measures curve and linear functions don't change slope. Therefore the answer is (c), the only linear utility function.)

Which of the following is a demand function for good 2 if good 2 is a complement for good1? Assume that income and quantities demanded are always positive. (a) 𝑥2(𝑝1, 𝑝2, 𝑚) = (3𝑚)/(4𝑝2) (b) 𝑥2(𝑝1, 𝑝2, 𝑚) = (𝑝1)/(6𝑚) (c) 𝒙𝟐(𝒑𝟏, 𝒑𝟐, 𝒎) = 𝒎/(𝟑𝒑𝟐)− (𝒑𝟏)/(𝟗𝒎) (d) 𝑥2(𝑝1, 𝑝2, 𝑚) = 7 (e) None of the above

(c) 𝒙𝟐(𝒑𝟏, 𝒑𝟐, 𝒎) = 𝒎/(𝟑𝒑𝟐)− (𝒑𝟏)/(𝟗𝒎)

Suppose that the demand for a good is given by D(p) = 10 - p, where p is the price of the good. The supply curve forthe good is perfectly elastic at a price of $4 per unit. What is the deadweight loss of a tax $2 per unit applied to sellersof the good? (a) 10 (b) 8 (c) 4 (d) 2 (e) 0

(d) 2

This month, Lillie grows 10 peaches and 8 bananas on her farm. At the market this month, she can buy or sell asmany peaches as she wants for $2 each, and buy or sell as many bananas as she wants for $1 each.Last month, Lillie grew 3 peaches. The price of each peach was $4 last month, but she had the same budget constraintline as she does this month (i.e., she has the same set of affordable bundles in both months). Lillie cannot save orborrow, and she must consume peaches and bananas in the same month they are grown. How many bananas did Lilliegrow last month? (a) 20 (b) 26 (c) 24 (d) 22 (e) None of the above

(d) 22 This month: 2p+b=2*10+8=28 in order to have the same budget constraint the price ratio must be the same. Since the price of peaches has doubled. the price of bananas must also double and income must double. last month: +2b=2*28=56=4*3+2*bananas -> bananas = (56-12)/2=22

In the Macarena Forest, there are 100 people with positive reservation wages. 20 people have adaily reservation wage of $50, 40 people have a daily reservation wage of $90, 30 people have a dailyreservation wage of $150, and 10 people have a daily reservation wage of $230. How many people willbe hired if the daily offered wage is $175? (a) 40 (b) 60 (c) 80 (d) 90 (e) None of the above

(d) 90 Only 90 people have a reservation wage less than the offered wage of 175.

If the real interest rate is 20% and the inflation rate is 10%, what is the nominal interest rate? Solve for the exactanswer. (a) Between 8% and 9.5% (b) 10% (c) 30% (d) Between 31% and 35% (e) More than 40%

(d) Between 31% and 35% 1+p=(1+r)/(1+n) 1+0.2 + (1+r)/(1+0.1) 1.2*1.1=1+r 1.32-1=r 0.32=r

Pete receives $50 today (time period 1) and $60 one year from today (time period 2). His annual interest rate is 20%,there is no inflation during the next year, and he has intertemporal preferences consistent with the utility functionܷܿ U(c1 c2)=c1^3 c2^3. If he maximizes his intertemporal utility, he will _____ today. (a) Borrow $5 (b) Save $5 (c) Borrow $50 (d) Neither save nor borrow (e) None of the above

(d) Neither save nor borrow

In a fictitious town of Fruitlandia, 4 individuals each buy apricots following their individualdemands P = 6 - Q and 1 individual buys following individual demand P = 11 - Q, where Pdenotes the price and Q denotes the quantity. For the price range between $0 to $6, the town'saggregate demand is given by (a) P = 35 - 5Q (b) P = 17 - 2Q (c) P = (17/2) - (Q/2) (d) P = 7 - (Q/5) (e) None of the above

(d) P = 7 - (Q/5) Between $0 and $6 all 5 individuals are in the market.We have 4 individuals with q=6-P and one individual with q'=11-P, therefore overall demand is Q=4q+q'=24-4P+11-P=35-5P, soP = 7 - (Q/5).

Which of the following is true when there is a tax imposed in a market with perfectlyinelastic supply? Assume that the amount of the tax is less than the price before the tax isimplemented. (a) Buyers pay all of the tax (b) Buyers pay some but not all of the tax (c) Price paid by consumers falls by the amount of the tax (d) Price paid by consumers does not change (e) None of the above

(d) Price paid by consumers does not change This is best shown using a general example:Let demand be D=b-P and supply S=a, where a and b are some constants. Notethat supply is constant and thus perfectly inelastic.Before a tax: Set demand equal to supply:D=S then: b-P=a so that P=b-a and D=S=a.Now impose a tax on consumers so that demand is now D'=b-(P+t), where theprice now faced by consumers is (P+t).Set new demand equal to supply:D'=S then: b-(P+t)=a so that (P+t)=b-a.As we can see the price faced by consumers is still b-a, it doesn't change.

If a good is normal, then an increase in the price of the good will lead to which of thefollowing to be true for this good? (Assume that there are only two goods, the individual'spreferences lead to well-behaved preferences with strictly convex indifference curves and aninterior solution for all budgets). Let SE = substitution effect, IE = income effect ) (a) The magnitude of the IE for this good must be larger than the magnitude of the SE (b) The magnitude of the SE for this good must be larger than the magnitude of the IE (c) The good could be a Giffen good (d) The good must be an ordinary good (e) None of the above

(d) The good must be an ordinary good

The market for red widgets is characterized by an upward-sloping 45 degree supply curve and a highly elastic demand curve (almost flat). Suppose the equilibrium price of red widgets is $10/unit. Which ofthe following statements is true if a $5/unit tax imposed on the buyers in the market? (a) The buyers pay most of the tax and the quantity purchased decreases (b) The sellers pay most of the tax and the quantity purchased increases (c) The buyers and the seller each pay half of tax and the quantity purchased does not change (d) The sellers pay most of the tax and the quantity purchased decreases (e) None of the above

(d) The sellers pay most of the tax and the quantity purchased Following the imposition of a tax on buyers, the demand curve shifts down and the equilibrium quantitydeclines from q0 to q1 , meaning the quantity purchased decreases (and equilibrium price drops from p0to p1). The new buyers' price is pd = p1 + t (reading it off the original demand curve, D0), which is almostthe same as the original buyers' price (p0). The new sellers' price is p1, which is a large decrease from p0and reflects almost the full amount of the tax. So sellers pay most of the tax. See the graph below (notdrawn to scale). The material for this is in Lecture 1

In a town behind the local mountains, 3 individuals each buy flowers following theirindividual demands 𝑃 = 8 − 𝑄 and 2 individuals each follow their individual demand 𝑃 = 3 −𝑄. For prices between $0 to $3, the town's aggregate demand for flowers is given by (a) 𝑃 = 11 − 2𝑄 (b) 𝑃 = 30 − 5𝑄 (c) 𝑃 = 30 − 𝑄/5 (d) 𝑷 = 𝟔 − 𝑸/𝟓 (e) None of the above

(d) 𝑷 = 𝟔 − 𝑸/𝟓 Start by expressing demands in terms of quantities. We have 3 individuals thathave a demand of q=8-P and 2 individuals that have a demand of q'=3-P. Therefore, market demand is: Q=3(8-P)+2(3-P)=30 -5P Putting it in terms of price yields

Which of the following is a demand function for good 2 in which good 2 is a substitute for good 1? Assume thatquantities demanded of both goods are positive for answering this question. (a) 𝑥2(𝑝1, 𝑝2, 𝑚) = (2𝑚)/(3𝑝2) (b) 𝑥2(𝑝1, 𝑝2, 𝑚) = 5 (c) 𝑥2(𝑝1, 𝑝2, 𝑚) = (𝑚)/(𝑝2)− (𝑝1)/(5𝑚) (d) 𝒙𝟐(𝒑𝟏, 𝒑𝟐, 𝒎) = (𝟑𝒑𝟏)/(𝟒𝒎) (e) None of the above

(d) 𝒙𝟐(𝒑𝟏, 𝒑𝟐, 𝒎) = (𝟑𝒑𝟏)/(𝟒𝒎)

A bond is currently selling for $100. This bond only has one remaining payment to bondholders, a face value of $Xtwo years from today. If the annual interest rate is 20% for this bond, what is X? (a) Less than $80 (b) More than $80 but less than $100 (c) $100 (d) More than $100 but less than $140 (e) $140 or more

(e) $140 or more

James is a utility-maximizer with well-behaved preferences, strictly convex indifference curves, andhe considers leisure a normal good. He has $200 per week in non-wage income and 98 hours to allocateto leisure or labor per week. Suppose his wage goes down from $25 to $20 per hour and his demand forleisure increases from 60 hours per week to 70 hours per week. Which of the statement must be correctto be consistent with James' choice? (a) James' reservation wage increased (b) James' reservation wage decreased (c) For consumption, the substitution effect is positive (d) For leisure, the income effect is larger than the substitution effect in absolute value (e) For leisure, the substitution effect is larger than the income effect in absolute value

(e) For leisure, the substitution effect is larger than the income effect in absolute value The decline in the wage does not change James' reservation wage, because the reservation wagedepends only on preferences, the maximum number of hours available, and non-wage income. So (a) and(b) are both false.The substitution effect is positive for leisure and negative for consumption (because leisure has becomerelatively cheaper). So (c) is false.Because leisure is a normal good and wages are declining, the income effect for leisure is negative.Furthermore, overall demand for leisure has increased, so it must be that the substitution effect is largerthan the income effect, making (e) the correct answer. The material for this is in Lecture 11

In an insurance market, which of the following must be true if someone fully insures? (a) Consumption in the bad state must be larger than in the good state (b) Utility must be maximized if this person is risk loving (c) The number of dollars of accident insurance purchased is less than the amount of thepotential loss (d) The probability of a loss occurring is less than one-half (e) None of the above

(e) None of the above (a)? No, full insurance implies equal consumption in both states (𝑐𝑏 = 𝑐𝑔) (b)? See lecture 16, slide 25. If someone is risk loving, utility is usually maximized by purchasingno insurance, not full insurance (c)? When fully insured, K (the number of dollars of accident insurance purchased) equals L (theamount of the potential loss) (d)? This might be true, but is not necessarily true (e)? Since a-d are not true, this is the correct answer

If demand is given by D(p) = 200 - 2p, what is the consumers' surplus if price is 60? (a) 1200 (b) 2400 (c) 3600 (d) 4800 (e) None of the above

(e) None of the above Consumer surplus is the area below the demand curve but above the given price. Let's rearrange the demand function so that we can graph it in the quantity-price space.𝑞 = 200 − 2𝑝 → 𝑞 + 2𝑝 = 200 → 2𝑝 = 200 − 𝑞 → 𝑝 = 100 − 1/2 𝑞We can plot this demand curve and also the point on the demand curve where price is 60. This pointwhere the price is 60 corresponds to a quantity of 𝐷(𝑝) = 200 − 2 ∗ 60 = 200 − 120 = 80. Thus, the length of this triangle is 80 and the height of the triangle is 40. So,CS=(1/2)*(80)*(40)=1600. Since none of the answers are 1600, the answer is

(2) If good 1 is normal and ordinary, then an increase in the price of good 2 must lead to which of thefollowing to be true? (Assume there are only two goods.) (a) Good 2 must be a complement for good 1 (b) Good 2 must be a substitute for good 1 (c) Good 2 must be Giffen (d) Good 2 must be inferior (e) None of the above

(e) None of the above Emphasis on MUST be true, so we will use process of elimination. Without further information we can't say (a)or (b). To see this, consider a Cobb-Douglas utility function. It satisfies all information given, but doesn't satisfy(a) or (b). For (c) and (d), we do not know if good 2 is inferior or normal so that means the answer is (e).

Steven has non-labor income each week of $500. He can work up to 100 hours per week foran hourly wage of $10 per hour. His utility for recreation (R) and consumption (C) is given by𝑈(𝑅, 𝐶) = 2𝑅^2𝐶. What is Steven's reservation wage if the price of consumption is unity? (a) $30 (b) $40 (c) $50 (d) $60 (e) None of the above

(e) None of the above The reservation wage is equal to the MRS when the individual has L=0. Therefore,we need to find the MRS at L=0, R=100, C=M=500. 𝑀𝑅𝑆 = (2(2𝑅)𝐶)/(2𝑅^2) = (2𝐶)/𝑅 = 1000/100 = 10

Which of the following best defines full insurance? (a) Number of dollars of accident insurance purchased is less than the potential loss (b) The cost of insurance is fair (c) The price of bad consumption (d) The cost of insurance is less than the probability of the loss occurring (e) Number of dollars of accident insurance purchased is equal to the potential loss

(e) Number of dollars of accident insurance purchased is equal to the potential loss

Today you have paid $400 for an investment that pays $200 in one year, $800 in three years,and $X in 5 years. Assuming the market interest rate is 100% and the net present value of theinvestment is zero, what must be true about X? (a) X is equal to $2,500 (b) X is greater than or equal to $2,000 but less than $2,500 (c) X is greater than or equal to $1,500 but less than $2,000 (d) X is greater than $1,200 but less than $1,500 (e) none of the above

(e) none of the above Use NPV: 400 = 200/(1 + 1) + 800/(1 + 1)^3 + 𝑋/(1 + 1)^5 400 = 100 + 100 + 𝑋/32 𝑋 = 6400

You currently know the following information about Chip: He is a high-school graduate, with both consumption andleisure as normal goods. He receives $500 per week from his aunt. For all possible hours of work, the absolute value ofChip's ŵargiŶal rate of suďstitutioŶ is greater thaŶ ϮϬ (assuming leisure is on the horizontal axis). The highest wage he can currently earn is $13 per hour.Suppose that Chip's wage increases to $ϭ7 per hour. Which of the following could possibly happen to Chip if heis always a utility maximizer? (If more than one answer is possible, pick answer (e).) (a) Chip will work 50% more hours than before .(b) Chip will work the same number of hours as before. (c) Chip will work fewer hours than before. (d) Chip will work 25% more hours than before. (e) More than one of the above answers is possible.

.(b) Chip will work the same number of hours as before. Whenever MRS > w, Chip chooses not to work. Since MRS > 20 > 17 > 13, Chip chooses not to work under both w

If crackers are a complement to cheese, this means that (choose one of the following): A. Demand for crackers decreases when the price of cheese increases. B. Demand for crackers increases when the price of cheese increases. C. Demand for crackers decreases when the price of crackers increases. D. Demand for crackers increases when the price of crackers increases. E. None of the above

A. Demand for crackers decreases when the price of cheese increases. (for complements, the demand for one good decreases (increases) when the price of the good increase (decreases))

(5) Consumer 1 has individual demand given by q = 70 - p. Consumer 2 has individual demandgiven by q = 120 - 2p. If these are the only two consumers of the good being analyzed, what isthe market demand when the price of the good is 30? A. 130 B . 100 C. 60 D. 40 E. 20

B . 100 When p=30, 1 demands 70-30=40 and 2 demands 120-2*30=60. aggregated demand 40+60=100

A consumer has a 50% chance of consuming 16 units of a good, and a 50% chance ofconsuming 25 units of a good. What is this consumer's expected utility if 𝑈(𝑐) = √𝑐? A. 4 B . 4.5 C. 5 D. 8.5 E. 9

B. 4.5 𝐸𝑈 = 𝑃1 𝑈1 + 𝑃2 𝑈2 = 0.5 ∗ √16 + 0.5 ∗ √25 = 2 + 2.5 = 4.5

Jana only consumes apples and bananas, and she has an endowment of 10 apples and 4 bananas. Bananas cost$2 each, and Jana has an income of $18. Jana consumes 8 apples when their price is $1 each, and apples are an inferior good. If the price of apples increase from $1 to $1.05 each, Jana's demand for apples will: A. Increase, since the substitution and income effects are both positive. B. Decrease, since the substitution and income effects are both negative. C. Decrease, since the substitution effect is bigger than the income effect. D. Change in an indeterminate direction, since the substitution effect and the income effect have oppositesigns. E. None of the above

B. Decrease, since the substitution and income effects are both negative. (when the price of apples increases, substitution effect is negative. Increase in price increases real income given that Jana is a net seller of apples. Apple is an inferior good, so income effect is negative)

If glops and blurbs are goods that are substitutes for each other, which of the following is most likely to be true? A. If the price of a blurb increases, the quantity of glops consumed decreases B. If income increases, the quantity of glops and blurbs consumed decreases C . If the price of a glop decreases, the quantity of blurbs consumed decreases D. Glops and blurbs must both be Giffen goods E. If both prices are positive, the budget constraint must be positively sloped

C . If the price of a glop decreases, the quantity of blurbs consumed decreases

When analyzing questions related to substitution and income effects of two goods, which ofthe following is always true? Assume changes in quantities due to substitution and incomeeffects to be non-zero. A. The compensated budget is parallel to the original budget B. The utility-maximizing choice on the compensated budget is indifferent to the utility-maximizing choice on the new budget C . The compensated budget is parallel to the new budget D. A normal good will always have a positive change in quantity due to the income effect E. None of the above is correct

C . The compensated budget is parallel to the new budget

Katja and Mariella are identical twins; they have exactly the same preferences. Katja has $30 income today, and will receive $44 of income in one year time. Mariella has $25 of income today, and will receive $50 of income in one year's time. Katie and Marialla are equally well off. (i.e. each of them is indifferent between their own chosen consumption bundle and their twin's chosen consumption bundle).The inflation rate is zero. What is the value of the real interest rate A. 5%/year B. 10%/year C. 20%/year D. 25%/year E. Not enough information to tell

C. 20%/year

In the market for used cars, the current price of a used car is $1,000. If the market demand is denoted by𝑃 = 1,800 − 𝑄, what is total consumers' surplus for used cars? (a) $640,000 (b) $320,000 (c) $160,000 (d) $0 (e) None of the above

Consumer's surplus is defined as the area between the demand curve and price. To measure the area, need tocalculate the base and height of the triangle. The base is given by the equilibrium quantity (Q*):1000 = 1800 − 𝑄 → 𝑄 ∗ = 800Height is the difference between the price at quantity equal to 0 (vertical intercept) and the current price:𝑃(𝑄 = 0) − 𝑃(𝑄 ∗) = 1800 − 1000 = 800Then, the area is given by:𝐶𝐶 = 800 × 800 × 1/2 = 320000→ (b) is the correct answer

Willie's preferences for recreation (R) and consumption (C) are consistent with the utilityfunction 𝑈(𝑅, 𝐶) = 700𝑅 + 20𝐶. The price of consumption is unity, and he has 100 hours perweek for recreation and consumption. What is Willie's per-hour reservation wage? A. Less than $10 B. At least $10 but less than $20 C. Exactly $20○ D . More than $20 but less than $40 E. $40 or more

D . More than $20 but less than $40 Perfect substitutes with 𝑀𝑅𝑆 = 700/20 = 35 .By definition, at reservation wage, Willie should be indifferent between working or not. MRS= price ratio => 𝑤 $ = 35

Creola has fully insured so that she will consume $600 in both the good and bad state of the world. Withoutinsurance, she would have received $800 in the good state and $0 in the bad state. How much does each dollar ofinsurance cost, rounded to the nearest penny? (Assume that the per-dollar price of insurance is constant.) (a) $1.33 (b) $0.75 (c) $0.33 (d) $0.25 (e) None of the above

Her consumption in the bad state of the world is 𝑐𝑏 = 𝑚 − 𝐿 + 𝐾 − 𝛾𝐾 600 = 0 + 800 − 800𝛾 𝛾 = (800 − 600)/800 = 0.25→ (d) is the correct answer.

Jo Dee earns $550 today and will earn $1100 one year from today. If consumption today is on the horizontal axis andconsumption one year from today is on the vertical axis, what is the vertical intercept of the intertemporal budgetconstraint? Assume an annual interest rate of 10%. (a) $1500 (b) $1600 (c) $1705 (d) $1815 (e) None of the above

If consumption one year from today is on the vertical axis, the vertical intercept of the intertemporal budgetconstraint represents the maximum amount of consumption possible one year from today given 0 units consumedtoday. The maximum amount of consumption one year from today for Jo Dee is given by: 𝑐1 + 𝑐2/(1 + 𝑟) = 𝑚1 + 𝑚2/(1 + 𝑟) → 0 + 𝑐2/(1.1) = 550 + 1100/1.1 → 𝑐2 = 1550(1.1) = 1705→ (c) is the correct answer.

For this problem, assume that a consumer's utility function is well-behaved (positive marginal utility for allconsumption levels, diminishing marginal rate of substitution, strictly convex), and that consumption is always positivefor each of two goods available. These goods are x and y. If y is a Giffen good, which of the following statements is truewhen there is an increase in the price of good y? (a) The SE implies an increase in the consumption of good y (b) The IE implies a decrease in the consumption of good y (c) For good y, the absolute value of the IE is larger than the absolute value of the SE (d) The SE implies no change in the consumption of good x (e) More than one of the above answers is correct

If the price of y increases, then the change in quantity due to the SE is positive for x and negative for y (due to theincrease in the price y). The change in quantity due to the IE is positive for y (since it must if it is a Giffen good), andnegative for x (since at least one of the two goods must be normal). The IE must dominate for y, since y is assumed to be a Giffen good.The above information implies that only (c) is correct.

Malcolm has been endowed with 10 bicycles and 100 rulers. The price per bicycle is $100 and the price per ruler is$1. Which of the following consumption bundles has Malcolm breaking even from buying and selling these two goods?(Note that "breaking even" here means that he does not save or borrow after buying and selling one or more of thecommodities.) (a) 100 bicycles and 10 rulers (b) 5 bicycles and 600 rulers (c) 0 bicycles and 1000 rulers (d) 12 bicycles and 0 rulers (e) None of the above

Malcolm's income based on his endowment is 10(100) + 100(1) = 1100. Malcolm would be breaking even withany bundle that costs exactly $1100. (a) 100 bicycles and 10 rulers → 100(100)+10(1)=10010 (b) 5 bicycles and 600 rulers → 5(100)+600(1) = 1100 (c) 0 bicycles and 1000 rulers → 0(100)+1000(1) = 1000 (d) 12 bicycles and 0 rulers → 12(100)+0(1) = 1200 Therefore, the correct answer is (b)

In the Macarena Forest, there are 100 people with positive reservation wages. 20 people have adaily reservation wage of $50, 40 people have a daily reservation wage of $90, 30 people have a dailyreservation wage of $150, and 10 people have a daily reservation wage of $230. How many people will be hired if the daily offered wage is $175? (a) 40 (b) 60 (c) 80 (d) 90 (e) None of the above

Only 90 people have a reservation wage less than the offered wage of 175.

(2) Tony has preferences for labor and leisure that is consistent with the utility function𝑈( 𝑅 , 𝐶) = 50𝑅 + 5𝐶, with R hours of leisure and C dollars of consumption. (Note that the priceof consumption is unity here.) What is his hourly reservation wage?(a) $10 (b) $15 (c) $30 (d) $60 (e) None of the above

Reservation wage is the wage at which a worker is indifferent between working and notworking. This means that at the reservation wage: • R is equal to the total number of hours (T), • C is equal to non-labor income (m), and • The budget constraint and indifference curve must be tangent at (R,C)=(T,m). Then, reservation wage can be found by setting the MRS and price ratio equal at (T,m): 𝑴𝑹𝑺 = 𝟓𝟎/𝟓 = W𝑹 = 𝐫𝐞𝐬𝐞𝐫𝐯𝐚𝐭𝐢𝐨𝐧 𝐰𝐚𝐠𝐞 W𝑹 = 𝟏𝟎→ (a) is the correct answer.

Irene is an expected utility maximizer. Her utility function is given by 𝑈(𝐶) = √𝐶. She must choosebetween two lotteries, L1 and L2. L1 pays $100 with 40% probability and $0 with 60% probability. L2pays $Y with certainty. What is a possible value for Y that will make Irene choose L2 over L1? (a) 7 (b) 9 (c) 12 (d) 36 (e) None of the above

The expected utility of L1 = 0.4 √100 + 0.6 √0 = 4. For any value Y, the expected utility of L2 is √𝑌. So the expected utility of L2 > expected utility of L1 for any value of Y>16, making (d) the correct answer. The material for this is in Lecture 15.

You earn money and can spend this money only this year and next year. Your utility functionis 𝑈(𝑐1 , 𝑐2 ) = 𝑐1^0.5.& 𝑐2^0.25. You can save and borrow as much as you want at an annual interestrate of 20%. If you earn $25,000 this year and $200,000 next year, what is the largest amount you could consume next year? (a) $225,000 (b) $170,000 (c) $230,000 (d) $175,500 (e) None of the above

The right answer is (c).

Ollie's garden grows 500 strawberries (s) and 100 kiwis (k) each year. He can buy and sell as many strawberriesand kiwis as he wants at the farmer's market. His utility function is !(#, %) = min(#, 3%). Which of the followingstatements is true if Ollie maximizes his utility? (HINT: You do not need to know prices to answer this question) a) He will be a net seller of strawberries b) He will be a net buyer of strawberries c) He will consume no kiwis d) His marginal rate of substitution will be equal to the price ratio of the two goods e) Not enough information to kno

a) He will be a net seller of strawberries

Sonja is considering buying accident insurance for her car. She has $10000 of income, and her car is worth$2000. If the car is in an accident, and she is uninsured, she loses its entire value. Let her consumption in "good" state (where no accident occurs be Cg and consumption in the bad state (where an accident occurs) be Cb. The probability of the bad state occurring is 0.1. Sonja's preferences over contingent consumption can be represented by the expected Utility function EU (Cg,Cb) =0.1(Cb)^2 + 0.9 (Cg)^2 If insurance costs $0.10 per dollar of coverage, how much insurance does Sonja buy? a. $0 b. $2000 c. $200 d. $160 e. not enough info

a. $0 (quadratic utility function, sonja is risk-loving. This is a fair insurance. Sonja will not purchase any insurance)

Roger's reservation prices rn for consuming n=1,2,3,4,5 burritos are: r1 $18 r2 $15 r3 $13 r4 $9 r5 $6 if the market price of a burrito is $10, how many burritos will Roger consume? a) 1 b) 2 c) 3 d) 4 e) 5

c) 3 (roger's reservation prices for n=1,2,3 are higher than the market price, so Roger will consume 3 burritos)

Andy has expected utility preferences over risky consumption bundles. He has a choice between a safe optionof receiving $325 for sure, or a gamble with a 25% chance of receiving $1,000 and a 75% chance of receiving$100. Andy strictly prefers the gamble over the safe option. Which of the following is consistent with Andy'spreferences? a) Andy is risk-averse b) Andy is risk-neutral c) Andy is risk-loving d) Andy's utility function for safe consumption is concave. e) None of the above

c) Andy is risk-loving

Assume that there are only two goods, x and y, and that y is an ordinary and inferior good. Income is only frommoney, there is no endowment income. Which of the following is TRUE for good y when the price of yincreases? a) The income effect is larger in magnitude than the substitution effect b) The substitution effect increases demand for y. c) The substitution effect is larger in magnitude than the income effect. d) The income effect reduces demand for y. e) None of the above

c) The substitution effect is larger in magnitude than the income effect.

Today you have paid $275 for an investment that pays $100 in one year, $500 in two years,and $X in 4 years. Assuming the market interest rate is 100% and the net present value of theinvestment is zero, what must be true about X? (a) X is greater than $2,500 (b) X is greater than or equal to $2,000 but less than $2,500 (c) X is greater than or equal to $1,500 but less than $2,000 (d) X is greater than $1,200 but less than $1,500 (e) X is less than or equal to $1,200

c) X is greater than or equal to $1,500 but less than $2,000 Use NPV: 275 = 100/(1 + 1) + 500/(1 + 1)^2 + 𝑋/(1 + 1)^4 275 = 50 + 125 + 𝑋/16 𝑋 = 1600

Molly's utility function for recreation (R) and consumption (C) is U(R,C) = R1/4 C3/4 . If the price of consumption is1, Molly's non-wage income is $90 per day, and she can allocate 15 hours per day to labor or recreation, herreservation wage is: a) $1 per hour b) $1/12 per hour c) $18 per hour d) $2 per hour e) None of the above

d) $2 per hour

Christine receives $10 of income this week, and will receive $24 next week; she never receives anything else.She can save and borrow as much as she wants at a weekly interest rate of 20%. One unit of consumption costsone dollar, and there is no inflation. Which of the following consumption combinations is affordable? a) Consume $34 of goods this week and $0 next week b) Consume $32 of goods this week and $0 next week c) Consume $0 of goods this week and $38 next week d) Consume $0 of goods this week and $36 next week e) None of the above

d) Consume $0 of goods this week and $36 next week