Remaining Terms

Question 1

Example of Utility (Perfect Substitutes)

Answer 1

U(x,y) = ax + by

Question 2

Examples of Utility (Perfect complements)

Answer 2

U(x,y) = min{ax,by}

Question 3

Examples of Utility (Cobb-Douglas Function)

Answer 3

U(x,y) = A(x^y)(y^c)

Question 4

Examples of Utility Function (One good is bad)

Answer 4

U(x,y) = -ax + by

Question 5

For utility functions MRS is…

Answer 5

the slope of the indifference curve.

Question 6

If the utility function is

u(x,y) = x(y^2)

Answer 6

x(y^2) = C
y = Square Root(c/x)

Question 7

What is the budget constraint generally?

Answer 7

Px * x + Py * y

Question 8

Whats the slope of the budget line?

Answer 8

Marginal Rate of Transformation

Px/Py

Question 9

Why do budget lines shift?

Answer 9

Because of shifts in income

Question 10

Why do budget lines rotate?

Answer 10

Because of a change in the price of one good.

Question 11

Perfectly Elastic

Answer 11

Infiniti

Question 12

elastic

Answer 12

Ed > 1

Question 13

Inelastic

Answer 13

Ed

Question 14

Unit Elastic

Answer 14

Ed = 1

Question 15

Price Elasticity of Supply

Answer 15

Income/Cross Price Elasticity = tell about sensitivity of curve behavior in response to changes in income and other input factors

Question 16

Sales Tax

Answer 16

Ad Valorem Tax (Tax is fraction of good’s total price)

Question 17

Specific/Unit Tax

Answer 17

Gas tax (added per unit of the good sold)

Question 18

What is the major tradeoff in economics?

Answer 18

Efficiency vs. Equity

Question 19

What are the key differences between a perfectly inelastic demand curve and a perfectly elastic demand curve?

Answer 19

1. ) Perfectly inelastic demand is characteristic of a good with no substitutes.
   a. ) Insulin
2. ) Perfectly elastic demand is characteristic of a good with perfect substitutes.
   a. ) Cola wars

Question 20

What does elasticity represent about consumers’ responses?

Answer 20

Their response to a change in price.

Question 21

If the elasticity is between 0 and -1 then firms can…

Answer 21

raise revenues by raising the price (since consumers will still buy the good in significant quantities

Question 22

If the elasticity is less than -1 then…

Answer 22

raising the price results in a decline in firm revenue.

Question 23

What are the three imposed assumptions about consumer preferences?

Answer 23

1. ) Preferences are complete.
2. ) Preferences are transitive
3. ) Preferences cannot be satiated.

Question 24

What are the four assumptions made about indifference curves stemming from the three imposed assumptions about indifference curve.

Answer 24

1. ) Consumers prefer higher indifference curves.
2. ) Indifference are downward sloping
3. ) Indifference curves never cross
4. ) there is one indifference curve through every consumption bundle.

Question 25

Utility function is a function that…

Answer 25

transfers bundles of goods into a scale of utils; however, it provides only an ordinal ranking not a cardinal ranking.

Question 26

A general assumption that is made…

Answer 26

is diminishing marginal utility: as more is consumed the consumer receives less utility.
or
a.) The consumer receives less utility with each consecutive unit that is consumed.

Question 27

MRS =

Answer 27

(MUx)/(MUy)

• The ratio of marginal utilities.
• The utilities diminish as you move along the indifference curve

Question 28

An increase in price has two effects

Answer 28

1. it makes the consumer relatively poorer (income effect)

2. ) It also makes specific goods less attractive relative to alternatives (substitution effect).

Question 29

The substitution effect can be interpreted as the shift in…

Answer 29

goods consumed from the original point to the optimal point for a budget for a budget constraint that has the new slope, but is tangent to the old indifference curve.

Question 30

1. ) Substitution effect is always…

2. ) Income effect can be…

Answer 30

1. ) negative.

2. ) positive or negative.

Question 31

1.) Accordingly, the overall effect of price increase on a normal good can be…

Answer 31

1.) Negative or positive.

Question 32

A good with a positive own-price elasticity is known…

Answer 32

as a Giffen good

Question 33

If the good is inferior then the income effect..

Answer 33

is larger than the substitution effect

Question 34

income and substitution effects can be used to analyze…

Answer 34

labor supply

Question 35

Leisure

Answer 35

(time not spent working) is a consumption good, and the price of that good is the wage, since that is the opportunity cost of time not spent working.

Question 36

When the wage rate increase, this has both an income effect and a substitution effect.
- Expand

Answer 36

• Income effect: each worker is now richer, and may want to work less (represented by an increased consumption of leisure)
  2.) Substitution Effect: returns to working are higher, each worker may want to work more.
  (Policy Implication = if the income effect more than offsets the substitution effect, labor supply may go down when income increase.)

Question 37

How does the marginal rate of substitution change as you move along a non-linear indifference curve?

Answer 37

• It’s downward sloping
• A non-linear indifference curve is concave to the origin, and the marginal state of substitution is declining as you move along the indifference curve to the right.

Question 38

What is an appropriate intuitive explanation of the principle of diminishing marginal utility?

Answer 38

Everyone gets tired of consuming the same thing eventually.

Question 39

How do “normal” and “inferior” goods differ in regard to their income effects?

Answer 39

‘Normal’ and ‘inferior’ are descriptive terms that can be used to describe whether the income effect is positive or negative, but they are not separate components of an overall price effect.

Question 40

How can it be explained when consumption falls when the price increases?

Answer 40

Consumption falling when price increases is the most common case of own-price effect, where the substitution effect dominates the income effect.

Question 41

When we model the consumer’s trade-off between consumption and leisure, what is the slope of the budget constraint?

Answer 41

The wage rate.

Question 42

If the income effect dominates the substitution effect in the labor supply decision, what happens when the wage increases?

Answer 42

Workers work less.

Question 43

Why would a worker work more after getting a raise if the income effect dominates?

Answer 43

When the wage increases, there is both an income effect (each worker feels relatively richer) and a substitution effect (each hour of work has higher returns.) A richer worker will want to consume more leisure (since it is a normal good), and thus will work less. On the other hand, the fact that each hour of work has higher returns may impel a worker to work more. If the first (income) effect dominates, then workers will work less at a higher wage.

Question 44

If rural households in Vietnam begin to earn more money for their crops and become richer, what will happen to the supply curve for their children’s labor? (Hint: assume that education is a normal good.)

Answer 44

• It will shift left
• If education for children is a normal good, families will consume more of it (i.e., school attendance will increase) when their income increases. Accordingly, the supply curve for child labor will shift left because children are spending more time in school

Question 45

What is the key difference between a weakly preferred set and a strictly preferred set in relation to the indifference curve?

Answer 45

The weakly preferred set includes the indifference curve and everything to the northeast whereas a strictly preferred does not include the indifference curve and consists solely of everything to the northeast.