Name:___________________________ SID:__________________________

GSI name: ______________________ Section #:__________________________

ECON 100A

FALL 2012

MIDTERM I

Instructions

BREATHE!

This exam starts at 4:10 pm and ends precisely at 5:30 pm. No extensions

will be granted.

Before you hand in the exam, make sure your name AND SID are at the top

of the page, as well as your GSI’s name.

By taking this exam, you acknowledge that the use of outside materials is

not permitted. Anyone caught using outside material, including your

neighbor’s exam, will get 0 points on the exam.

Before you start working, read the questions carefully.

If you have any questions, ask!

GOOD LUCK!

PART I

Mark whether the following statements are true or false. No explanation needed.

1. If cereal and milk are perfect complements and the price of milk decreases, the

substitution effect is smaller than the income effect.

TRUE FALSE

2. George will buy Bananas only when they cost $1 a pound. His demand for Bananas is

inelastic.

TRUE FALSE

3. If price elasticity of demand is negative then the good must be normal.

TRUE FALSE

4. Consumer surplus is a cardinal measure.

TRUE FALSE

5. Tom and Jeri both love cheese, but Jeri’s demand for cheese is more elastic. For a given market

price, Jeri’s consumer surplus is higher than Tom’s.

TRUE FALSE No points should be deducted

6. The compensated demand curve is more elastic than the uncompensated demand curve when a

good is normal.

TRUE FALSE

7. An increase in income will shift the Engel curve to the right.

TRUE FALSE

8. If cross-price elasticity of two goods is +1%, then the goods are neither complements nor

substitutes.

TRUE FALSE

9. The slope of the indifference curve tells us how much money we need to forgo in order to buy

one more unit of good X.

TRUE FALSE

10. Daniel consumes pizza (x-axis) and sushi (y-axis). The price of pizza is $3 a slice and the price of a

sushi is $6. The MRS at Daniel’s current consumption bundle is 1/3. To maximize utility Daniel

should consume less sushi and more pizza.

TRUE FALSE

This question was mis-graded. Please get the professor to change your grade if you

put false and got points off for that.

PART II – SHORT ANSWER QUESTIONS

1. Harold regards pizza (x-axis) and burgers (y-axis) as imperfect substitutes. The price of burgers

decreases and Harold consumes the same amount of pizza.

a. Graph this scenario and mark the price-consumption curve on your graph.

b. Can U = X2·Y be a utility function representative of these preferences? Show with math

why or why not.

For part b, you had to find the demand for good y and see whether px was in that expression. If so, then

clearly it cannot be represented by these preferences.

MUx/MUy = 2XY/X2 = Px/Py

2PyY = PxX

2PyY = M – PyY -> Y = M/3Py

Since the demand for Y does not include the price of good X, then this potentially could be a

representation of the preferences above.

Price consumption curve

Pizza

Burgers

2. For a price increase of good X, draw X as an inferior good. Be sure to mark your income and

substitution effects clearly on your graph.

3. Trace the demand curve for a Giffen good by using the 2-panel graph I showed in class: on the

top panel find two optimal bundles for different prices. On the bottom panel, plot the

corresponding demand curve. Make sure your axis are labeled.

4. Define the term transitivity. Give an example of non-transitive preferences and explain how this

could be a problem.

If A is preferred to B and B is preferred to C then A is preferred to C.

Example of non-transitive preferences: Joseph prefers Heineken to Guinness and Guinness to

Leffe, but when offered the choice between Heineken and Leffe, he chooses Leffe.

Such preferences mean that

Long-Answer Question

1. James, Pierre’s twin, consumes coffee and cigarettes, which he regards as imperfect substitutes.

One day he wakes up to the terrible news that the government imposed a 200% tax on cigarettes

and that drought conditions in South America lead to the price of his favorite coffee to double.

a. Draw James initial consumption bundle, and his budget constraint after the price changes. You

may choose the axis.

What you had to figure out here is that a 200% tax increase triples the cost of cigarettes, while

the price of coffee doubles.

b. James parents hear about his hardships and decide to increase his stipend so he can purchase

the same bundle he purchased before. Add this budget constraint to your graph.

c. Given the new prices and his additional stipend, will James consume more or less coffee than his

initial bundle? (HINT: he has to maximize utility)

A – original B.C.

B – B.C. after the price change

C - B.C. after parents compensation. This B.C. crosses through the original bundle, but since its

flatter it has to be above the original B.C. on the right. This means that James will consume more

coffee and less cigarettes.

d. Pierre complains to his parents that the stipend they gave James is too high and claims that if

they gave him a Hicksian compensation they will save money AND James will also smoke less

than he did before the price changes. Is the Hicksian compensation going to save money to

James and Pierre’s parents? Is James going to smoke less that he did before the price changes?

Explain your answer.

In blue I marked the Hicksian compensation allocation – where utility is the same as the original

bundle. Pierre is right that his parents will save money if they use this compensation since

Hicksian compensation is always less than Slutsky. Relative to the original bundle, James will

consume less cigarettes and more coffee. But it will be more cigarettes and less coffee relative

to the Slutsky compensation.

NOTE: The answers are the same, even if you put coffee on the y-axis – the graph will look

different, but the answers will be the same.