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ECO 306 Exam I Fall 2021

Answer 3 of the following 4 questions. Answer all parts of the three questions chosen.

NEATNESS COUNTS. If I have to struggle to read your responses they may be marked wrong.

Provide HANDWRITTEN responses only, please. Nothing typed. Staple multiple sheets of paper. Provide clean

edges on the paper. Clearly label your responses (a, b, c…).

- Suppose a consumer’s bi-weekly income is $1000, Px = 10, and Py = 5.

a) Draw the budget line, clearly labelling the intercepts with specific quantities of x and y.

b) What is the economic rate of substitution?

c) Draw a Cobb-Douglas (i.e., typical) utility curve showing the optimal bundle (clearly indicating that

optimal point).

d) What must be the MRS at the optimal bundle?

e) Suppose a tax is placed on good y, raising the price by $5. Show in a graph, how this affects the

budget constraint and the optimal choice of x, y. Be sure to show the before (pre-tax) and after (posttax) budget line, etc.

f) In part e, based on your chosen optimal point, is x a normal good? Explain briefly. - Consider the trade-off between muffins and coffee. Suppose that at the current level of consumption, the

consumer is willing to trade 2 muffins for a cup of coffee. The price of muffins is $2 each and the price for each

coffee is $4.00. The consumer has $20 to spend (each week) on muffins and coffee (and always spend all of it).

a) What is the consumer’s MRS?

b) Is the consumer currently in equilibrium? Explain.

c) What must the consumer do to move closer to equilibrium? - Consider two goods, bus tickets/rides and taxi rides. Suppose that the prices for similar distances are PBus =

$1.00 and PTaxi = $3.00. The consumer has $30 to spend per week on bus tickets and taxi rides.

a) Draw this individual’s budget constraint.

b) Draw indifference curves that show a relatively stronger preference for taxi rides than bus tickets.

Explain (in words) how the indifference curves you have drawn show a relative preference for taxi rides.

Indicate the optimal point for the consumer on the graph.

c) Redraw the original budget constraint on a new graph. To encourage greater use of taxis, suppose the

bus company offers a discount of 20% on the first three rides/tickets. Draw the new budget constraint.

d) Describe the MRS along the new budget constraint. - Suppose the current market price for good X is $10 and the current equilibrium quantity (of X) is 100 units.

a) Draw the demand curve for X, labelling the axes and the optimal point.

b) Assuming the price elasticity of demand is -2, show on the graph the result of a 10% decline in price.

Clearly label the new optimal point values (on the P and X axes).

c) Assume good X has an income elasticity of demand of -1.5. Show on the graph from part b the effect

on demand of an increase of consumer income. Be sure to indicate changes to the demand curve, if any,

and the value of the new quantity demanded.

d) If the cross-price elasticity between this good and another is 0.75, what will happen to quantity demand

of X if the price of the other good decreases? Be precise.