Department of Economics: ECO 204 Microeconomic Theory For Commerce 2013 - 2014 Test 1 Solutions
Department of Economics: ECO 204 Microeconomic Theory For Commerce 2013 - 2014 Test 1 Solutions
Department of Economics: ECO 204 Microeconomic Theory For Commerce 2013 - 2014 Test 1 Solutions
Department of Economics ECO 204 Microeconomic Theory for Commerce 2013 - 2014
Test 1 Solutions
IMPORTANT NOTES:
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the exam
Please note that proctors will take down your name for academic offenses, which will be treated in accordance with the policies as
published by the Faculty of Arts and Sciences.
Exam details:
Duration: 2 hours and 20 minutes
Total number of questions: 9 (see next page of test for breakdown of points)
Total number of pages: 32 (including title page)
Total number of points: 100
Please answer all questions. To earn credit you must show all calculations.
Exam aids:
This is a closed note and closed book exam.
You may use a non-programmable calculator. Sharing is not allowed.
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Page 2 of 32
THIS TABLE IS FOR GRADERS USE ONLY
PAGES 3 11: SHORT QUESTIONS
TOTAL POINTS FOR SHORT QUESTIONS 31
SHORT QUESTION MAXIMUM POINTS SCORE COMMENTS
1 11
2 3
3 5
4 3
5 9
PAGES 12 33: LONG QUESTIONS
TOTAL POINTS FOR LONG QUESTIONS 69 + 2 BONUS
LONG QUESTION MAXIMUM POINTS SCORE COMMENTS
1 17
2 19
3 15 + 2 BONUS
4 18
TOTAL SCORE OUT OF 100 POINTS
GOOD LUCK!
KEEP YOUR ANSWERS AS BRIEF AS POSSIBLE AND SHOW ALL NECESSARY CALCULATIONS
Page 3 of 32
SHORT QUESTIONS
Short Question 1 [11 POINTS]
The following function is defined on the domain [ ):
()
Here are parameters.
(a) [2 POINTS] For what values of is this function concave? Show all necessary calculations.
(b) [2 POINTS] Assume . Solve the following problem:
()
Show all necessary calculations.
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(c) [2 POINTS] Calculate the change in
due to a small change in the parameter by two separate methods. Show all
necessary calculations.
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Short Question 2 [3 POINTS]
Consider the following general inequality constrained optimization problem:
()
Here is a constant and the function () is defined on the domain [ ). Your friend Crak-Bob attempts to
solve this problem by setting it up as follows:
()
() [ ]
()
[ ]
[ ]
Has Crak-Bob set up this problem correctly? If so, interpret if not, then set up but do not solve the problem
correctly. Show all necessary calculations.
Page 6 of 32
Short Question 3 [5 POINTS]
Consider the following inequality constrained optimization problem:
()
Here is a constant and the function () is defined on the domain [ ). Prove that that the optimal value of the
Lagrange multiplier
equals
(
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Short Question 4 [3 POINTS]
Consider the UMP:
The utility function is defined on the consumption set {(
from
the UMP below:
Give a very brief explanation.
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Short Question 5 [9 POINTS]
(a) [3 POINTS] A consumer perceives two goods to be good goods and prefers to consume them as complements.
She prefers to consume four units of good 2 for every two units of good 1. Write down at least three utility functions
which represent this consumers preferences. Show all necessary calculations.
Page 10 of 32
(b) [3 POINTS] Suppose
898 797
Here
average price per oz. of soda sold per week across all seven stores of
the supermarket chain. Currently,
7
(a) [10 POINTS] Suppose that the government has proposed imposing a 2% excise tax on all soda sold in this
supermarket chain. Calculate the potential impact on the representative soda consumers utility due to the proposed
2% excise tax. Show all necessary calculations and state all necessary assumptions. Provide all numerical answers to 4
decimal places.
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(b) [3 POINTS] True or false: if instead of imposing an excise tax on soda, the government were to tax the supermarkets
(soda) customers income, the income tax would not impact the quantity of soda sold? Show all necessary calculations
and state all assumptions.
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(c) [4 POINTS] True or false: in general, a flat income tax is less bad for consumers than an excise tax on good 2 that is
designed to raise the same amount of tax revenue dollars as the flat income tax? Show all necessary calculations.
Assume both goods are good goods.
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Long Question 2 [19 POINTS]
(a) [3 POINTS] When faced with the budget constraint
):
Now suppose that the price of good 1 falls from
to
) where
. Faced with this budget constraint, suppose the consumer chooses bundle C = (
):
)
C
A
The total price effect of good 1 due to its lower price is:
) where
.
Explain why the optimal choice bundle B = (
)
A
Page 18 of 32
)
C
A
)
B
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(b) [4 POINTS] In part (a), we saw that in order to isolate the substitution and income effects, starting at budget
constraint
) we imagine taking away income until the original bundle A becomes affordable this yields
the budget constraint
) where
in terms of
and
Show all
necessary calculations.
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(c) [4 POINTS] [THIS PART IS INDEPENDENT OF ALL REMAINING PARTS BELOW]
Evaluate these statements separately:
True or false: a Giffen good must be an inferior good.
True or false: an inferior good must be a Giffen good.
Give a brief explanation.
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(d) [8 POINTS] Suppose that a consumer has the utility function:
(
)
Suppose that initially
) ( ) and then
) ( ). Calculate the
total price, substitution and income effect on good 1.
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Long Question 3 [15 POINTS]
Ajaz and Michelle live for exactly two days ( ) and are addicted to the game Call of Duty (just as Rob Ford is
addicted to crack). To keep their gaming addiction under control, the game keeper gives Ajaz and Michelle one token
on each day specifying the maximum number of hours that Ajaz and Michelle can play Call of Duty on that day. Let
and
and
Michelles utility for gaming is:
Their endowments of tokens are both fixed at 5 hours per day, i.e.
.
Ajaz and Michelle are the only two people in this game and they can choose to trade tokens with each other. Currently,
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(c) [1 POINTS] According to your calculation above, is the current interest rate in this gaming economy too high, too
low, or just fine? Show all necessary calculations.
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(d) [5 POINTS] Draw Ajazs inter-temporal UMP problem on to the following graph and show the consumption and
endowment points, the equilibrium indifference curve, and net savings over the two periods.
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(e) BONUS [2 POINTS] Calculate the equilibrium real interest rate at which Ajazs savings equal Michelles borrowings.
Show all necessary calculations. Provide numerical answers to 4 decimal places.
Page 28 of 32
Long Question 4 [18 POINTS]
(a) [3 POINTS] Consider the following general UMP:
The utility function is defined on the consumption set {(
) } Show that if goods 1 and 2 are good goods
then expenditure must equal income. Show all necessary calculations.
Page 29 of 32
If the consumer likes at least one good then shell expend her entire income (budget).
(b) [15 POINTS] Consider the following general UMP:
The utility function is defined on the consumption set {(