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Q1. Colette consumes goods x and y. Her indifference curves are described by the formula y =
k/(x + 7). Higher values of k correspond to better indifference curves.
A. Colette likes good y and hates good x.
B. Colette prefers bundle (12, 16) to bundle (16, 12).
C. Colette prefers bundle (8, 5) to bundle (5, 8).
D. Colette likes good x and hates good y.
E. More than one of the above statements are true.
ANS B. Given any consumption bundle (x, y), solve for the value of k, which gives you level
of the indifference curve. So, for the bundle A = (12, 16) the corresponding vlaue is ka = 1619
while for the bundle B = (16, 12) the corresponding value is kb = 23 12. Since ka > kb , B
is true. Moreover for any A = (x, y) and B = (x0 , y 0 ) are such that x > x0 and y y 0 , then
ka = (x + 7)y > (x0 + 7)y 0 = kb , so A cannot be true and so on.
Q2. Nicks indifference curves are circles, all of which are centered at (12, 12). Of any two indifference circles, he would rather be on the inner one than the outer one.
Hint: Formula for the square of distance of a point (x, y) from (12, 12) is (x 12)2 + (y 12)2 .
A. Nicks preferences are not complete.
B. Nick prefers (16, 17) to (10, 10).
C. Nick prefers (10, 17) to (10, 10).
D. Nick prefers (8, 8) to (17, 21).
E. More than one of the above statements are true.
ANS D. Just use the above formula in each case. For instance, the square of the distance of
(8, 8) from (12, 12) is (8 12)2 + (8 12)2 = 32 whereas the same for (17, 21) is (17 12)2 +
(21 12)2 = 106. So the (8, 8) is closer to (12, 12) and is hence preferred.
Q3. If there are only two goods, if more of good 1 is always preferred to less, and if less of good 2
is always preferred to more, then indifference curves
A. slope downward.
B. slope upward.
C. may cross.
D. could take the form of ellipses.
1
C. It has the same effect as reducing the income, keeping the prices fixed.
D. Both B and C.
E. None of the above.
ANS B This is clear, since the new budget line lies below the old budget line with the X
intercept being M/(px + t) and the Y intercept being M/(py + t). Note D is not the answer,
since new slope of the budget line is (px + t)/(py + t) if it were teh same as changing the
income, then the slope would have remained at px /py .
Q8. Suppose A B but the indifference curve through A intersects the one that goes through B.
A. Preferences violate transitivity.
B. Preferences violate completeness.
C. Both A and B.
D. Not enough information to conclude either way.
ANS A.
Q9. Suppose we double the prices and income.
A. The consumers demand must remain unchanged.
B. If initially more of X is consumed relative to Y , then even more X will be consumed.
C. If initially more of X is consumed relative to Y , now less of X will be consumed.
D. Any of the three cases is possible, it depends on the initial income.
E. Depends on which goods price was initially higher, more of that good will now be consumed.
ANS A. We talked about it in class (when I referred to lack of money illusion) with such
a change in income and prices the new budget constraint is the same as the old one.
Q10. The price of Y is fixed at $2. The price of X is $2 for until first 5 units but drops to $1 for
every additional unit. If the income is $20,
A. The budget set is a triangle.
B. The budget set cannot be determined.
C. The budget set is such that there exist consumption bundles A and B both of which are
feasible but their average is not feasible.
D. Need to know the preferences to compute the budget set.
E. None of the above.
if x 5
10 + (x 5) + y = 20
if x > 5
Or x + 2y = 15.
if x > 5
(1)
(2)
Draw the two lines described by Eq. (1) and Eq. (2) They will look as shown first part of
Figure 1. Taking the relevant portions, the budget set is the region described by the thick
lines in the other picture. The inward kink shows that we must be able to find two points on
the boundary whose average lies outside the shaded region.
Y
10
10
15
15