Essay Economics

Econ 2200 Midterm #1 Fall 2011 - - - Sketch Answers

Section I

a. The Income Effect results from a change in the price of the good, nominal income does not change, but “real income” Or purchasing power changes. A change in income results from a change in nominal income, no change in prices.

b. False. The budget line shows the market’s willingness to trade. The MRS gives the consumer’s willingness to trade.

c. See text.

d. See text.

e.

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f. Rebecca is correct. The slope of the budget line is PM/ PG which equals 1. Since he values one more movie twice as much as he values one more session at the gym, his marginal utility for movies is twice as much as his marginal utility for gym sessions. That is, his MUM is 2, and his the MUG is 1. The ratio of MUM/MUG is greater than the slope of the BL. Therefore¸ his current choice is not optimal.

Section II

Q1.

a. Qd = 40 – 2.5Po +0.1(200) = Qd = 60 – 2.5Po set equal to QS = 1.5P – 8.

4P = 68, P =17

b.

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c. The price elasticity of demand:

(Q,P = -b(P*/Q*)

= -2.5(17/17.5)

= (-2.43 (

Demand is Elastic and a one percent change in price will lead to a 2.43 percent change in quantity demanded.

Income elasticity of demand:

(Q, I = (Q/(I(I*/Q*)

= 0.1(200/17.5)

= 1.14

Oranges are a normal good since the sign is positive. A 1% change in income leads to a 1.14 % change in the quantity of oranges demanded.

d. When P =$20, Qd= 10 while Qs = 22, there is a surplus 12 bushels. The amount exchanged in the market is the lesser of the two: 10

Q2. U(x1, x2) = x12 x22

a. Monotonic, Diminishing Marginal Rate of Substitution

b. MU1 = 2x1x22

MU2 = 2x12 x2

MRS = MU1/MU2

= 2x1x22/2x12 x2

= x2/x1

Jonathan’s optimal choice will be an interior solution (a tangency point) on the Budget Line where MRS = P1/P2

12.5x1+ 5x2 =500...