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You are on page 1of 12

Department of Economics

Solutions Will Not Be Posted

Instructions:

Closed book test. Non-programmable, non-graphing calculator permitted, but should not be necessary. No

headphones permitted to be worn during the test. Regrade requests accepted only if the test is written in

pen, not in pencil.

Be conscious of the time remaining. Do the easiest problems first. Make sure you have enough time to

attempt every question.

Violations of academic honesty are taken very seriously, will result in an automatic F in the course, and the

student will be turned over to the student’s Dean of Students for further repercussions. Please do not

consider running afoul of the policy, and if you unclear about what constitutes a violation, please ask.

Good luck!

Question 1 – Short Answers

Answer the following questions very briefly (keep an eye on the clock!):

a. What is transitivity? Explain in words and write down the relevant preference

relations.

b. “Thick” indifference curves are the result of violating which axiom? How does

this violation produce thick indifference curves? Give intuition.

2

c. True or false, and explain. (Hint: still false, credit for the explanation.) “For

normal goods, when income increases, and all else held constant, the supply curve

(with Q on the horizontal axis and P on the vertical axis) shifts to the left. For

inferior goods, it shifts to the right.”

3

Question 2 – Supply and Demand

Consider the markets for guacamole, which is sold in jars in supermarkets, in San Diego

and in New York. The supply and demand functions for supermarket guacamole in San

Diego, respectively, are:

QsSD = 20 + pSD – paSD

QdSD = 100 – pSD + pfSD

where pSD is the price of guacamole in San Diego, paSD is the price of avacadoes in San

Diego (an input for making guacamole), and pfSD is the price of crushed durian fruit in

San Diego (which is a close substitute to guacamole for consumers). In New York, the

supply and demand functions are given by

QsNY = 20 + pNY – paNY

QdNY = 100 – (pNY)3 + pfNY

Notice that that the price term is cubed in the NY demand function, it is not in the SD

demand function.

a. Find the effect of a small change in the price of durian fruit on the equilibrium

price of guacamole in San Diego. That is, calculate dpSD/dpfSD. You may do this

anyway you like, but you must end up with dpSD/dpfSD by itself on the left hand

side of the equation. What is the effect of a small change in the price of durian

fruit on the equilibrium quantity supplied and on the equilibrium quantity

demanded. That is, what is dQsSD/dpfSD and dQdSD/dpfSD. Any method is fine.

4

b. Repeat part a. for New York. That is, calculate dpNY/dpfNY, dQsNY/dpfNY, and

dQdNY/dpfNY. For this part, you may leave your answer as a function of pNY, paNY,

pfNY if you like, but you must end up with dpNY/dpfNY, dQsNY/dpfNY, and

dQdNY/dpfNY on the left hand side of their respective equations.

5

c. Find the price elasticity of demand in San Diego at the equilibrium San Diego

price pSD. (This should be a function only of paSD and pfSD.)

d. How would a change in the price of durian fruit in San Diego, pfSD, affect the

equilibrium value of the price elasticity of demand in San Diego? Does this

elasticity rise or fall in absolute value? What, if anything, does it depend on?

6

Question 3 – Consumer Choice

Fransiska consumes two goods, cantaloupe (c) and watermelon (w). She has a utility

function given by U ( q c , q w ) = q c q w and wishes to maximize utility. The price of

watermelon (which are pretty big) is pw and the price of cantaloupe (not quite as big) is

pc. Fransiska’s income is Y.

a. Set up the Lagrangian and write down the first order conditions.

b. Solve for the optimal number of cantaloupe and watermelon Fransiska will

purchase, as a function of pw, pc, and Y.

7

c. Draw Fransiska’s optimal point in a carefully labeled diagram.

Show this mathematically.

8

e. Does the law of demand hold for watermelons for Fransiska? Does the law of

demand hold for cantaloupe for Fransiska? Are watermelons a normal good or an

inferior good? Are cantaloupe normal or inferior?

f. Calculate the fraction of her income that she spends on watermelon. Calculate the

fraction of her income that she spends on cantaloupe. What is interesting about

this result?

9

g. Calculate the indirect utility function for Fransiska.

10

i. Now let’s consider a different type of problem. Assume Fransiska must achieve a

fixed utility level of U . Solve for her Hicksian demand functions.

11

k. Verify that Shephard’s Lemma holds.

l. Verify the Slutsky equation holds for a change in the price of good watermelons.

That is, calculate the left hand side of the equation and the right hand side of the

Slutksy equation directly using the Marshallians and Hicksians above, and then

show the left hand side equals the right hand side. Identify the terms that represent

1) the ordinary income effect, 2) the endowment income effect, 3) the substitution

effect, and 4) the total effect of the change in the price in watermelons.

12

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