Midterm Exam

What happens to the marginal rate of substitution as you move along a convex indifference curve? A linear indifference curve?

-Along a convex indifference​ curve, the marginal rate of substitution decreases -Along a linear indifference​ curve, the marginal rate of substitution is constant

Describe the indifference curves associated with two goods that are perfect substitutes. What if they are perfect complements?

-The indifference curves for two goods that are perfect substitutes are downward-sloping straight lines -The indifference curves for two goods that are perfect complements are shaped as right angles

Marginal Rate of Substitution (MRS)

-is equal to the ratio of the prices (Px/Py) -(Px/Py) decreases as an individual moves downward along the demand curve (willing to trade less and less y for an additional unit of x) and increases as an individual moves upward along the demand curve

Chapter 3

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Chapter 4

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Chapter 19

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Chapter 5

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You walk into your local grocery store and see two packages of ground beef that are identical aside from their labeling. One is labeled "80% lean," and the other is labeled "20% fat." Which package are consumers more likely to buy and what behavioral economic concept does this example illustrate?

80% lean, and framing

A​ price-consumption curve shows A. the​ utility-maximizing combinations of two goods as the price of one good​ changes B. the​ utility-maximizing combinations of two goods as the prices of those goods​ change C. the difference between what a consumer is willing to pay for a good and the amount actually​ paid D. the quantity of one good consumers are willing to buy as consumer income​ changes

A

During periods of high stock market​ volatility, the standard deviation of returns on the stock market increases. If the expected return on the stock market does not​ change, a risk averse investor who wants to reduce the risk of his portfolio will A. increase the proportion of his portfolio that is invested in the​ risk-free asset and earn a lower expected return on his portfolio. B. decrease the proportion of his portfolio that is invested in the​ risk-free asset and earn a higher expected return on his portfolio. C. decrease the proportion of his portfolio that is invested in the​ risk-free asset and earn a lower expected return on his portfolio. D. increase the proportion of his portfolio that is invested in the​ risk-free asset and earn a higher expected return on his portfolio.

A

Suppose you have drawn a​ consumer's budget line for food and clothing with food on the horizontal axis and clothing on the vertical axis. If the prices of food and clothing remain the same and the​ consumer's income​ increases, A. the budget line shifts outward in a parallel fashion. B. the budget line becomes flatter. C. the budget line shifts inward in a parallel fashion. D. the budget line becomes steeper.

A

Using your knowledge of behavioral​ economics, explain why many people choose to have low deductibles on their automobile insurance policies. A. These people fall victim to the bias called the law of small numbers where they have a tendency to overstate the probability on certain events​ occurring, such as having a car crash. B. These people are using the concept of anchoring by fixing their deductibles at the lowest level possible until new information comes in that would make them change it. C. These people are expressing their views regarding the fairness of the system. They realize that their chances of getting into an accident are​ low, while others have a higher​ probability, and they do not want to subsidize these people. D. All of the above are true.

A

Why are some people likely to be risk averse while others are risk​ lovers? A. A​ person's risk aversion​ (or risk​ loving) depends on the nature of the risk involved and on the​ person's income. B. A​ person's risk aversion​ (or risk​ loving) depends on the nature of the risk​ involved, but it is independent of income. C. A​ person's risk aversion​ (or risk​ loving) depends only on the​ person's income. At low levels of income people are risk​ averse, but at high income they become risk loving. D. A​ person's risk aversion​ (or risk​ loving) depends only on the​ person's income. At low levels of income people are risk​ loving, but at high income they become risk averse.

A. A​ person's risk aversion​ (or risk​ loving) depends on the nature of the risk involved and on the​ person's income.

For which of the following goods would a 10 percent price increase lead to the largest income effect for most​ consumers? A. Housing B. Salt C. Movie tickets D. Cell phone service

A. Housing, the most money is spent on this good

Which of the following is an example of the endowment​ effect? A. The promotion by some firms that lets people return an item after 30 days if they are not completely satisfied. B.The observation that most Superbowl commercials are done by large established firms. C. The fact that McDonalds is growing much slower than Starbucks. D. The reluctance of some rich individuals to leave large sums of money to their kids for fear they will waste it.

A. The promotion by some firms that lets people return an item after 30 days if they are not completely satisfied.

An indifference curve shows all combinations of two goods that A. the consumer would choose at different prices. B. provide the consumer with the same level of satisfaction. C. cost the same amount of money. D. the consumer would choose at different levels of income

B

An individual demand curve A. relates the quantity of a good that a single consumer will buy to its price, while a market demand curve is all the individual demand curves multiplied together. B. relates the quantity of a good that a single consumer will buy to its price, while a market demand curve relates the quantity of a good that all consumers in a market will buy to its price. C. relates the quantity of a good that consumers in a market will buy at one particular price, while a market demand curve relates the quantity of a good that consumers in a market will buy at all prices. D. both A and B are correct E. both B and C are correct.

B

An informational cascade occurs when A. investors feel like they never have enough information to make good investment decisions and hence never make any decisions at all. B. people make investment decisions based primarily on other​ people's decisions. C. people gather a great deal of information before making investment decisions. D. All of the above occur when there is an informational cascade.

B

What behavioral economic concept underpins the idea of a​ bubble? A. Loss aversion since people do not want to feel like they are missing out on earnings when they see others are earning very high returns. B. Informational cascades since bubbles often result from people making investment decisions based on what others are doing instead of based on sound financial analysis. C. Rules of thumb since bubbles are often started when people use the common financial recommendation to invest in a security when the price is rising. D. The endowment effect since people become much more willing to keep buying a security once they own it already. Their ownership causes them to overvalue the security beyond its true value.

B

What is a​ "rule of​ thumb"? A. It is one of a handful of facts that have been well established and proven empirically to be true that most people base their decisions on. B. A benchmark set by past experiences or societal customs that help you make decisions now. C. The average outcome from a situation where many people have made a decision. It gives the most expected outcome for any decision. D. It is one of a handful of facts that have been well established and proven empirically to be true that very few people base their decisions on.

B

Which of the following statements about buying stocks on margin is​ correct? A. Only highly risk averse investors will buy stocks on margin. B. Buying stocks on margin increases the risk of the​ investor's portfolio. C. Only risk loving investors will buy stocks on margin. D. Buying stocks on margin decreases the risk of the​ investor's portfolio.

B

Shopping at the local​ supermarket, you see a sign that offers a can of​ Campbell's soup for​ $0.79 per can. Later you notice a new sign that says​ "Limit 5 per​ person." How would you expect the new sign to affect purchasing​ behavior? A. It will have no impact on your decision since you already know the price of the​ item, the new sign does not give you any new relevant information. B. It will increase the likelihood that you will buy the​ item, or more of the item than you would​ have, since people like to rely on key pieces of information when deciding​ what, and how​ much, to buy. C. It will decrease the likelihood that you will buy the item since you will feel this type of deal is unfair to others and therefore will not engage in the activity. D. It will decrease the likelihood that you will buy the item since these types of deals will be viewed as a gimmick that consumers dislike being exposed to.

B, anchoring

What does it mean to say that a person is risk​ averse? A. The person has increasing marginal utility of income and prefers a certain income to a gamble with the same expected income. B. The person has diminishing marginal utility of income and prefers a certain income to a gamble with the same expected income. C. The person has diminishing marginal utility of income and prefers an uncertain income to a certain income. D. The person has increasing marginal utility of income and prefers an uncertain income to a certain income.

B. The person has diminishing marginal utility of income and prefers a certain income to a gamble with the same expected income.

A retail store offers a marketing program in which they suggest that consumers try the product for 30​ days, and if they​ don't like​ it, send it back. What behavioral economic concept is at issue​ here? A. New goods bias since consumers will always value new goods over older goods. This type of promotion will not work since consumers will likely return the product to get a newer item. B. Loss aversion since people will likely return the product before the 30 days are up to avoid being stuck with an item they may not fully like. C. Endowment effect since once the item is in their house they will feel ownership and value it​ more, making them less likely to return it. D. Saliency since it will serve as a signal to consumers that the product may not be very high​ quality, but that it can be returned if it is far below your lowest required quality needs.

C

How does the diversification of an​ investor's portfolio avoid​ risk? A. If an investor buys stocks that are positively​ correlated, as the number of stocks held​ increases, the overall variance of the portfolio increases. B. If an investor buys stocks that are positively​ correlated, as the number of stocks held​ increases, the overall variance of the portfolio decreases. C. If an investor buys stocks that are negatively​ correlated, as the number of stocks held​ increases, the overall variance of the portfolio decreases. D. If an investor buys stocks that are negatively​ correlated, as the number of stocks held​ increases, the overall variance of the portfolio increases.

C

When is it worth paying to obtain more information to reduce​ uncertainty? A. Individuals are willing to pay more for information when the expected value of the choice with more​ information, including the cost of gathering the​ information, is greater than the certain value of the choice without the information. B. Individuals are willing to pay more for information when the expected value of the choice with more information is greater than the expected value of the choice without the information. C. Individuals are willing to pay more for information when the expected value of the choice with more​ information, including the cost of gathering the​ information, is greater than the expected value of the choice without the information. D. Individuals are willing to pay more for information when the expected value of the choice with more information is greater than the certain value of the choice without the information.

C

When the optimal point on an indifference curve and budget line diagram is a corner solution A. the consumer does not spend her entire budget on the two goods B. the budget line must have a kink in it. C. the marginal rate of substitution usually does not equal the ratio of prices for the two goods. D. All of the above.

C

Why is the variance a better measure of variability than the​ range? A. Variance weighs the sum of the difference of each outcome from the mean outcome by its probability​ and, thus, is a more useful measure of variability than the range. B. Variance is the average difference between the highest possible outcome and the lowest possible outcome​ and, thus, is a more useful measure of variability than the range. C. Variance weighs the squared difference of each outcome from the mean outcome by its probability​ and, thus, is a more useful measure of variability than the range. D. Range weighs the squared difference of each outcome from the mean outcome by its probability​ and, thus, is a less useful measure of variability than the​ variance, which uses empirical data to precisely measure variability.

C

What are the four basic assumptions about individual​ preferences? Explain the significance or meaning of each.

Consumer Theory assumes that ... 1. Preferences are complete, which means that consumers are able to compare and rank bundles 2. Preferences are transitive, which means preferences are consistent. If bundle A is preferred to bundle B, and bundle B is preferred to bundle C than bundle A is preferred to bundle C 3. More is always better, because all goods are desirable 4. The marginal rate of substitution diminishes where indifference curves are convex. MRS becomes less negative as you move down the indifference curve because consumers are willing to give less of good x for good y

Price-consumption curve

Curve tracing the utility-maximizing combinations of two goods as the price of ONE changes (People are maximizing utility --> happiness)

A firm is considering two policies to increase worker output. The first policy would involve an increased wage described as an incentive for workers to increase their effort. The second policy is to announce a voluntary bonus for those workers whose effort is deemed to be extraordinary. Using the insights from behavioral​ economics, which policy is likely to be more​ effective? A. The second policy will be more effective since it stimulates loss aversion in workers who would prefer to work through an incentive program and earn the money than to be given the money directly. B. The second policy will be more effective since it creates an endowment effect where workers would prefer to work through an incentive program and earn the money than to be given the money directly. C. The first policy will be more effective since it is more salient. Workers can assess the perceived importance of the two policies and will find the first one more salient. D. The first policy will be more effective since it creates an endowment effect where workers will value the additional money they actually receive more than the money they could possibly earn through the second policy.

D

At a museum you see a sign that says the​ following: "The amount you pay for a ticket for admission is up to​ you." As a​ result, you decide to pay​ $10 for a ticket as that seems to be a fair price.​ However, once you reach the ticket counter you see another sign​ saying: "Suggested admission is​ $25." Subsequently, you change your mind and decide to pay​ $25 for admission. Identify the behavioral economic concept illustrated in this example and how it influenced your decision. A. Saliency since the suggested price is giving you a signal as to the quality and quantity of the exhibits on any given day. You changed your donation since you realized the your experience will be worth more than you originally paid. B. Law of small numbers since the prices are so small you are indifferent to paying your initial amount or changing it to the slightly higher suggested amount. C. Framing since giving a suggested price is a more positive marketing strategy than saying the price is up to you. The new sign made you feel more positive about your upcoming experience and thus encouraged you to pay more. D. Anchoring since the suggested price gives you a reference point as to what is considered a fair​ donation, you decided to pay this reference price since you did not want to seem miserly.

D

Which of the following is not a way to reduce​ risk? A. Diversifying investments. B. Buying insurance. C. Obtaining more information about choices and payoffs. D. By considering fewer alternatives.

D

Why do people often want to insure fully against uncertain situations even when the premium paid exceeds the expected value of the loss being insured​ against? A.Assuming​ risk-averse individuals, the decrease in utility from a loss is greater than the increase in utility from a gain because of increasing marginal utility. B. Assuming the​ consumer's objective is to maximize expected​ utility, one must conclude that people are not always rational. C. Assuming the​ consumer's objective is to maximize expected​ utility, only if they are extremely risk averse is it rational for them to pay a higher premium to avoid a loss. D. Assuming​ risk-averse individuals, the decrease in utility from a loss is greater than the increase in utility from a gain because of diminishing marginal utility.

D. Assuming​ risk-averse individuals, the decrease in utility from a loss is greater than the increase in utility from a gain because of diminishing marginal utility. (the graph is the sqrt of x)

Expected Value

EV = Outcome1 * P1 + Outcome2 * P2 + ....

If the price of one of the goods changes, explain the effect on the quantity demanded of the other good. Are the goods substitutes, complements, or unrelated goods? I. bagels and cream cheese

If the price of one good increases the quantity demanded of the other good will decrease because they are complements

If the price of one of the goods changes, explain the effect on the quantity demanded of the other good. Are the goods substitutes, complements, or unrelated goods? III. haircuts and fresh fruit

If the price of one good increases, then the quantity demanded of the other good will remain unchanged because they are unrelated goods

If the price of one of the goods changes, explain the effect on the quantity demanded of the other good. Are the goods substitutes, complements, or unrelated goods? II. corn flakes and cheerios

If the price of one of the goods increases, the quantity demanded of the other good will increase because they are substitutes

Explain why two indifference curves cannot intersect

If two indifference curves​ intersect, then both transitivity and the more is better than less assumptions of indifference curves are violated.

How does utility increase in L shaped indifference curves

L shaped indifference curves means the goods are complements and they are consumed in a ratio. Meaning utility only increases when both goods are increased at the same time

Standard Deviation

Square root of variance

What is an endowment​ effect?

The tendency of individuals to value an item more when they own it than when they do not.

(T/F) : The level of utility increases as an individual moves downward along the demand curve. This statement is

True. As the price of a good falls, the budget line pivots outward, and the consumer is able to move to a higher indifference curve.

Perfect Complements (MRS)

Two goods for which the MRS is zero or infinity indifference curves are shaped as right angles

Perfect substitutes (MRS)

Two goods for which the marginal rate of substitution of one for the other is constant

Which of the following combinations of goods are complements and which are​ substitutes? Can they be either in different​ circumstances? Discuss. A mathematics class and an economics class

could be complements because a mathematics class may illuminate economics and an economics class may motivate​ mathematics, or they could be substitutes because a mathematics class and an economics class may conflict in scheduling.

Which of the following combinations of goods are complements and which are​ substitutes? Can they be either in different​ circumstances? Discuss Bacon and eggs

could be complements because they are often eaten together or could be substitutes because they are not often eaten together when served with pancakes.

Which of the following combinations of goods are complements and which are​ substitutes? Can they be either in different​ circumstances? Discuss. Steak and lobster

could be substitutes because they are listed as separate items on a menu or could be complements because they are often served together.

(T/F): Engel curves always slope upward. This statement is

false because Engel curves slope downward for Giffen goods.

If the price of one of the goods changes, explain the effect on the quantity demanded of the other good. Are the goods substitutes, complements, or unrelated goods? IV. travel by train and travel by plane

if the price of one of the goods decreases​, then the quantity demanded of the other good will decrease because they are substitutes

What is consumer surplus?

is the area under the demand curve and above price.

The standard deviation of the return on the stock market​ increases, but the expected return on the stock market remains the same. The budget line will ______________ and the slope will ____________ .The proportion of stocks in the portfolio ______________.

not shift, flatten, decrease

The expected return on the stock market​ increases, but the standard deviation of the stock market remains the same. The budget line will ______________ and the slope will ____________ .The proportion of stocks in the portfolio ______________.

not shift, steepen, increase

Individual demand curve

relates the quantity of a good that a single consumer will buy to its​ price

The return on​ risk-free Treasury bills increases. The budget line will ______________ and the slope will ____________ .The proportion of stocks in the portfolio ______________.

shifts up, flattens, increase or decrease

Income Effect

the change in consumption due to a change in purchasing​ power

Engel Curve

the quantity of one good consumers are willing to buy as that​ consumer's income​ changes

Substitution Effect

the substitution effect shows the effect of a change in consumption due to a change in relative prices.

(T/F): The marginal rate of substitution​ (MRS) diminishes as an individual moves downward along the demand curve.

true because the MRS equals Px/Py ​which decreases as an individual moves downward along the demand curve.

A risk neutral persons goes for

when expected value is highest

Loss aversion

avoiding losses over acquiring gains --> relates with risk

Suppose that an individual allocates his or her entire budget between two​ goods, food and clothing. Can both goods be​ inferior? Explain. Both goods....

cannot be inferior because an increase in income must be spent on one of the two goods. (If an individual consumes only food and clothing, then any increase in income must be spent on either food or clothing because we assume there are no savings)

Variance

V = (Outcome1 - EV)^2 * P1 + (outcome2 - EV)^2 * P2

A risk-averse person has

a diminishing marginal utility for income

Q(d) = 50 - 2P Q(s) = -10 + P what is the market clearing price and quantity? What is the consumer surplus?

a. 50 - 2P = -10 + P P = 20 50 - 2(20) = 10 Q = 10 b. Q(d) = 0 P= 25 25 - 20 = 5 * 10 *.5 = $25 is the consumer surplus

Market demand curve

all consumers demand

Which of the following combinations of goods are complements and which are​ substitutes? Can they be either in different​ circumstances? Discuss. Tennis balls and a tennis racket

are complements because they are both needed to play a game of tennis.

Which of the following combinations of goods are complements and which are​ substitutes? Can they be either in different​ circumstances? Discuss. A plane trip and a train trip to the same destination

are substitutes because they are two modes of transportation between the same two points.