UniversityofToronto,DepartmentofEconomics,ECO20420102011AjazHussain

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QUESTION1[25POINTS]
ThefollowinggraphandtableshowhowtheaverageU.S.consumerallocatesannualexpenditureof
$49,638across14categories:

Category %ofAnnualExpenditure
Food 12.4%
Alcohol 0.9%
Insurance 10.8%
Education 1.9%
Apparel 3.8%
Personalcare 1.2%
Healthcare 5.7%
Miscellaneous 1.6%
Housing 34.1%
Tobacco 0.7%
Transport 17.6%
Reading 0.2%
Cashcontributions 3.7%
Entertainment 5.4%
Total 100%

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(a)[5Points]WhichutilityfunctionwouldyouusetomodeltheaverageU.S.consumersannual
expenditureonthese14categories?Giveabriefexplanationforyourchoice,chooseparametersfor
yourutilityfunction,andwritedownthebudgetconstraint(i.e.setupbutdontsolvetheUMP).

(b)[10Points]Setupandsolvea2goodUMP(withLagrangemultiplier(s))inparametricform(i.e.
withoutnumbers)fortheutilityfunctionyouvechoseninpart(a).Hint:Forsimplicity,andifpossible,
useanaturallogtransformationorthetransformation(u) (forquasilinearutilityforms).Showall
calculations.

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(c)[10Points]Usethe2goodsanswersinpart(b)toderivea14categoriesversionofthemarginal
utilityofincome.

(d)[5Points]Usethe2goodsanswersinpart(b)topredicttheimpactontobaccosales(units)and
totalexpenditureontobacco(indollars)duetoa10%excisetaxontobacco.

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QUESTION2
Pleasereadandanswerthequestionsfollowingthisarticle:
Thedearthofbirths:WhyaresofewyoungJapanesewillingtoprocreate?
Nov18
th
2010(fromtheEconomistMagazine)

AT 84, Masuyo Hirano happily describes herself as in the spring of my life. The sprightly
woman lives in a nursing home with 50 other pensioners. But she is not idle. She votes. She
does acupuncture. She and her friends sing karaoke, their delicate hands wrapped around the
microphone. She dexterously weaves slippers from multicoloured ribbons that take days to
finish, and hands them out to visitors like sweets.
There are two reasons for her happiness. The first is that she has made satisfactory
arrangements for the remainder of her long life. In a country where 28m people are over 65 and
many millions live alone, are bedridden or suffer from dementia, she has found herself a place
that is a model of public-private care and will look after her until she dies. She has no children,
and will not need to ask her relatives to do anything further for her.
The second reason she is happy is that she knows what will happen to her remains after her
death. The Yashioen nursing home in Saitama, a district north of Tokyo, offers her a burial club
in which she and her friends will be placed in the same tomb together, which the nursing home
promises to tend. This sort of service is likely to become more popular in Japan as elderly
people have fewer children to mourn them. Many Japanese in their later years are tormented by
the prospect of lying in a lonely and forgotten tomb. Ive talked this over at length with my
nephews and nieces, she says. I dont want to be a burden on them.
When Ms Hirano was born in 1926, her parents generation was not expected to live beyond 50.
Today her age is nothing exceptional; life expectancy for women is 86 and for men 80. Japan
has known for decades that it was getting older. Its growing life expectancy, now the longest in
the world, was a cause for celebration as far back as 1962, when a special report by The
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Economist described it as possibly one of the most exciting and extraordinary sudden forward
leaps in the entire economic history of the world. The fruits of this success are now known as
hyper-ageing: no other country has grown so old so rapidly. The median age is approaching
50. That is surpassed only by Monaco, a Mediterranean retreat for wealthy pensioners.
Some of the stories about Japans enduring centenarians need to be taken with a pinch of salt.
This summer Tokyos supposedly oldest man, 111-year-old Sogen Kato, turned out to be a
heap of bones covered in newspapers dating from 1978. His daughter, now 81, had been
collecting his pension for decades. That event turned up a few similar cases. But for all the
missing centenarians, there are still reckoned to be about 40,000 bona fide ones. So many
have reached the age of 100 that the silver sake cups they are customarily awarded have been
reduced in size.
The darker side of that heartening picture of longevity is Japans shrinking birth rate, which at
1.4 per woman is the second-lowest in the rich world, after South Koreas. From the start of the
Meiji period in 1868 Japans population rose for about 70 years. During that time Japan cast off
its isolationist feudal system, opened its borders and started its headlong rush to
industrialisation. Then, in the 1950s, fertility started to plummet. Since the 1980s, when the birth
rate fell below 1.5 children per woman, Japan has, in effect, had a one-child policythough,
unlike in China, it was self-imposed.
It came as a shock to demographers when the 2005 census showed that the number of deaths
exceeded that of births for the first time: the population had started to shrink two years ahead of
schedule. The 2010 census results are currently being processed and preliminary results are
due in February 2011.
Go on, have another one
Since the mid-1970s, when it became clear that the number of births was resolutely declining,
Japanese governments have made efforts to encourage people to have more babies. But for all
that they have increased child benefits and provided day-care centres in the past 30 years, the
birth rate has remained stubbornly low. One reason is that in Japan, unlike in the West,
marriage is still more or less a prerequisite for having children. Only 2% of births take place out
of wedlock. And weddings cost a lot of money. The more elaborate sort may involve renting a
chocolate-box church and hiring or buying at least three bridal outfits. The average cost of a
Japanese wedding is about 3.2m ($40,000).
Having gone to all that trouble, married couples do, in fact, have an average of slightly more
than two children, just above what is needed for births to exceed deaths. The trouble is that
fewer and fewer people get married. Women wait ever longer and increasingly do not bother at
all. According to the NIPSSR, six out of ten women in their mid- to late 20s, which used to be
the peak child-bearing age, are still unwed. In 1970 the figure was two out of ten. And almost
half the men between 30 and 34 were unmarried in 2005, more than three times as many as 30
years ago.
But the cost of weddings may be the least of the reasons why the Japanese are increasingly
putting off marriage or avoiding it altogether. One weightier one is that employment rates among
women have increased but private companies implicitly discourage mothers from returning to
their old jobs. Toshiaki Tachibanaki, an economist who has written on inequality among
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Japanese women, finds that about 80% of female civil servants return to their old jobs after
having children because they get reasonable maternity benefits and help with child care. But in
private companies they are typically less well looked after, and only about a third go back to
work.
So most women are forced to take low-paid irregular or part-time jobs after having children.
NIPSSR figures show that the vast majority of working women aged 35-49 have jobs of that
kind, earning 500,000-1.5m a year. Most men in the same age group work in regular jobs (with
fringe benefits) and are paid 3m-6m.
It does not help that unemployment is high and incomes are low among the youngespecially
among young men, who increasingly give up even looking for jobs. One of Japans most
prominent sociologists, Masahiro Yamada of Chuo University, thinks that most young Japanese
women still want to be housewives, but are struggling to find a breadwinner who earns enough
to support them. He points out that half the young people of prime marrying age 20-34 still
live with their parents. In the 1990s he coined the term parasite singles to describe them. They
seemed to be getting a good deal, saving money on rent and spending it on foreign travel and
luxury goods instead. If they wanted privacy, they could always go to one of Japans ubiquitous
love hotels.
Leave me alone
Since then the parasites have got older, and a lot of them are living with their parents not
because they want to but because they cannot afford to live independently. They are moving
towards middle age but have remained single, working for low pay or unemployed. Some have
even become what Mr Yamada calls pension parasites, living on their parents pensions.
Part of the problem may be that young men, who during Japans free-wheeling boom era rarely
saw their workaholic fathers, do not want to fall into the same trap. Some of them have become
grass-eating men who prefer clothes and cosmetics to cars and avoid life in the fast lane.
Others resort to hikikomori, locking themselves in their bedrooms and refusing to talk to anyone,
even the parents who deliver food to them. Many of them have watched their mothers divorce
their fathers on retirement. Those men are cruelly known as dead wet leaves, whose wives
have trouble sweeping them out of the home. The Japanese are also learning from personal
experience that looking after elderly parents can be more costly and time-consuming than
looking after children. That may be another factor in their calculations.
Florian Coulmas of the German Institute for Japanese Studies in Tokyo, who has made a
special study of population issues in Japan, has no easy explanations for the low birth rate, but
describes it as the bitter fruit of success in Japanese demography. A growing percentage of
the population, both married and never married, without children has no vested interest in
society, with hitherto unknown consequences for its self-image and sense of purpose, he
writes. And even if policymakers managed to reverse those choices and persuade the Japanese
to have many more children, the benefits to the workforce would not be felt for 20 years.
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PartA:ModelingParasiteSingleswhowill(say)nevergetmarried
Inthissectionyouwillmodelandanalyzetheparasitesingles,almostmiddleagedmenliving with
their parents not because they want to but because they cannot afford to live independently.
(a)[5Points]OneexplanationforwhytheparasitesinglesarenotmarryingisbecauseMany of them
have watched their mothers divorce their fathers on retirement. Those men are cruelly known as dead
wet leaves, whose wives have trouble sweeping them out of the home. The Japanese are also learning
from personal experience that looking after elderly parents can be more costly and time-consuming than
looking after children. That may be another factor in their calculations [not to get married].Writedowna
utilityfunctionfortheseparasitessingleswhowill(say)nevermarryandgraphtheirindifferencecurves
belowwithnumberofweddingsasgood1andexpenditureonallothergoods(dollars)asgood2.

$E
2
Q
1

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(b)[5Points]Givenyouranswerinpart(Aa),doestheparasitesinglehaveatasteforvarietyand
monotonepreferences?Giveabriefexplanationandshowanyrelevantcalculations.

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(c)[10Points] SolvetheparasitessinglesUMPfortheoptimal
1
andE
2
andanyLagrangemultipliers.
Assume, P
1
> u andshowallcalculations.
r oseswithoutpriorpermission
Page11of32

PartB:Modelingsingleswhowontgetmarriedbecauseweddingsaretooexpensive
[IndependentofPartA]
InthissectionyouwillmodelandanalyzesingleswhowontgetmarriedbecauseOne reason is that in
Japan, unlike in the West, marriage is still more or less a prerequisite for having children. Only 2% of
births take place out of wedlock. And weddings cost a lot of money. The more elaborate sort may involve
renting a chocolate-box church and hiring or buying at least three bridal outfits. The average cost of a
Japanese wedding is about 3.2m ($40,000). Supposewecanmodelsuchindividualsbythequasilinear
utilityfunction:
u(
1
E = o
1
+ [ E
2
,
2
)
Hereo, [ > u,
1
= numberofweddings,E
2
= expenditure(dollars)onallothergoods.
(a)[10Points] Derivetheequationofanindifferencecurveforagivenlevelofutilityu,theyandxaxis
intercepts,andtheslope.Showallcalculationsandgraphtheindifferencecurvebelow.

$E
2
Q
1

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(b)[15Points] SolvethetoopoortogetmarriedsinglesUMPandLagrangemultipliers.Assume
, P
1
> u, showallcalculationsandexpressallresultsinparameterform(i.e.dontusenumbers).Show
allcalculations.

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SetP
1
= totheprice(indollars)ofaweddingmentionedinthearticle.AccordingtoJapaneseSummary
oftheLatestMonthonFamilyIncomeandExpenditureSurvey(October2010)theaverageJapanese
householdannualexpenditurewas$41,028(i.e.$E
2
= $41,u28).Supposethatatcurrentexpenditure
E
2
themarginalutilityofexpenditureisu.uu2S(i.e.Hu
L
2
= u.uu2S) andthatthemarginalutilityofa
weddingis3(i.e.Hu

1
= S).
Incaseyouneedit,thequadraticruleis:
+ bx + c +u ox
2

x =
-b _ b
2
- 4oc
2o

(c)[5Points] Whataretheparameters t n: o and[ intheutilityfunc io
u(
1
, E
2
) = o
1
+ [ E
2

Show,androundallcalculationstozerodecimalplaces.

(d)[5Points] Basedonyouranswersabove,howlowmustincomebeforthetoopoortogetmarried
singletostayunmarriedbecauseweddingsaretooexpensive?Showallcalculations

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(e)[10Points] SupposetheJapanesegovernmentseekstoboostbirthratesbysubsidizingwedding
costs.Calculatethesubsidyneededtogetthetoopoortogetmarriedsinglestogetmarried(once).
Showallcalculations.

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(f)[10Points] NowsupposetheJapanesegovernmentseekstoboostbirthratesbyanincomeincash
subsidy.Calculatetheincomesubsidyneededtogetthetoopoortogetmarriedsinglestoget
married(once).(Thispartshouldbeansweredindependentlyofpart(Be)).Showallcalculations.

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(g)[10Points] NowsupposetheJapanesegovernmentseekstoboostbirthratesurgingtoopoorto
getmarriedsinglestogetmarried(maybeanadvertisingcampaignweddingsarecool).Whatmust
thenewutilityfunctionbetopersuadetoopoortogetmarriedsinglestogetmarried?(Thispart
shouldbeansweredindependentlyofparts(Be)and(Bf)).Showallcalculations.

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(h)[5Points] BasedonthearticlesanalysisofdecliningbirthratesinJapan,suggestsomepoliciesto
increasebirthrates.

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PartC:ChinasOneChildPolicy
[IndependentofPartsA&B]
[10Points]SupposeChinesecoupleshavethefollowingutilityfunctionoverchildren(good1)and
expenditureonallothergoods(E
2
):
u(
1
, E
2
) =
1
+2 E
2

Assumeo, [ > u andallpecuniaryvariablesarepositive.SolvethisUMPinparametricform(without
numbers)withtheconstraintthatChinahadaonechildpolicy(i.e.nomorethan1childperfamily).
Showallcalculationsbelow.

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Question3
InarecentpaperHouseholdDemandforBroadbandInternetin2010(TheB.E.JournalofEconomics
AnalysisandPolicy),theauthorsestimatedthefollowingutilityfunctionfortheaveragebroadband
users in preferencesovervariouscharacteristicsofbroadband ternetservice:
u = -u.u21 C + u.94S FS +1.uu9 IFS + u.417 R + u.1S4 P +u.u92 IE + u.uuuu1 HI
+u.1u6 IF + u.u69 HR
Here:C = Cost,FS = Fastspeedinternetservice,IFS = Veryfastspeedinternetservice,R = Reliable
internetservice,P = Priorityofdownloadservice,IE = Telehealth(theabilitytoconnectwithhealth
professionalsonline),HI = Mobilelaptop(whetherlaptopcanbeconnectedtointernet),IF = Video
phone(whetherfreephonecallscanbemadeoverinternetandotherpartyseenonvideophone),and
HR = movierental(whetherHighDefinitionmoviescanberentedonline).
(a)[5Points]Whatarethemostandleastimportantcharacteristicsofbroadbandserviceforconsumers
(inabsoluteterms)?

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(b)[10Points]Howmuchareconsumerswillingtopayforasmallimprovementineachattribute
(holdingelseconstant)?Showallcalculations.

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Question4

PartA
Supposeaconsumerhasthefollowingutilityfunctio ds1and2: novergoo
u =
2
-
(
1
- o)
2
2[

Hereo,[ > u. Assumeallpecuniaryvariablesare>0andthatgood2isthebasegood.
(a)[10Points]SolvetheconsumersUMP.Assumebutdonotprovethatshehasmonotonepreferences.
Showallcalculations.

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PartB
[IndependentofPartA]
Gamsi,LaffontandVuongestimatedthefollowingdemandfunctionsforCokeandPepsiconcentrate
(syrup)basedonquarterlydata19681986(inEconometricAnalysisofCollusiveBehaviorinaSoft
DrinkMarke Economics t t, Journalof andManagementStra egy,Summer1992)
c

c p c p
= 26.17 - S.98 P + 2.2S P + 2.6u A - u.62 A + 9.S8 S + u.99 I

p
= 17.48 + 1.4u P
c
- S.48 P
p
- 4.81 A
c
+ 2.8S A
P
+ 11.64 S + 1.92 I
He
=quarterlyquantityofsyrupsold
re:

=priceofsyrup(1986dollars) P
=squarerootofquarterlyadvertisingexpenses(1986dollars) A
=equals1ifspring/summer,equals0ifwinter/fall S
I=realincome(1986dollars)
Theav a values h er ge oft esevariables were:

C
= Su.22,
P
= 22.72, P
C
= 12.96, P
P
= 8.16, A
C
= S.89, A
P
= S.28, I = 2u.6S
(a)[10Points]DerivetwodemandfunctionsforCoke:oneforspring/summerandtheotherfor
winter/fall.Showallcalculations.

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(b)[5Points]CalculateCokespriceelasticitiesinthespring/summerandfall/winter.

(c)[5Points]Ceterisparibus(allelseequal)whatistheimpactonCokesalesfroma1.25%increasein
prices?Showallcalculations.

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PartC
[CombinesPartsA&B]
(a)[10Points]SupposeCokesellsconcentratesyruptoasinglerepresentativeconsumer.Let
1
=
Cokeconcentratesyrupand
2
= everythingelse.Usethespring/summerandfall/winterdemand
functionsinPartBandtheutilityfunctioninpartAtoderivetwoseasonalutilityfunctions:oneforthe
spring/summerandtheotherforfall/winter.Showallcalculations.

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(b)[10Points]Writedownasingleutilityfunctionintermsofparametersthatgivesthetwoseasonal
utilityfunctionsasspecialcases.Showallcalculations.

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Question5(BonusQuestionextra10Points)
Youliketohavefinedinnersaftertests.Infact,rightafterthistest,youllgototheBlackHoofthe
restaurantandorderyourfavoritedishRawHorseSammytogetherwithalcohol(youliketohaveraw
horseSammyandalcoholascomplements).Asforalcohol,youcaneitherhaveChteauMouton
RothschildorChiantiasperfectsubstitutes.SupposerawhorseSammyisgood1,ChteauMouton
Rothschildisgood2,andChiantiisgood3.SolveyourUMP(assumeallpecuniaryvariablesarepositive).
Hint:SetuptheUMPintermsofonegoodonlyanduseintuition(whichbottleofwinewillyouorder?)

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