Microeconomics I

Midterm 2 (test A)
Nov. 15 (Fri.)
10:10-11:40
Name: __________________
Student ID: ______________

A. Multiple Choices (50%)

1. The Equivalent Variation resulting from a quota is best defined as
A) the amount a consumer would pay to have the quota removed.
B) the amount the consumer would need to voluntarily accept the quota.
C) the amount a consumer would pay for the quantity specified by the quota.
D) the loss in utility resulting from the quota.
Answer: A

2. You pay $15 for an all-you-can-eat buffet. The food isn't so good, but definitely edible.
When you finish eating, what is the marginal value of the last bite of food you consumed?
A) zero
B) $15
the reason
why IC) is also correct
For a Discrete utility X # times of bite
, =

C) positive
89M
0 1 2 Last bite > 7th : have MW .
= 0

D) negative X ,

Answer: A or C vixio 35 .

Mux-32 82 52 1 . . . 1 . 6 1 0 . 3-0 5
.
Mr descrease at a rate = 0 . 1x
when X I
>

3. To separate the income and substitute effects, the imaginary budget line should be
A) tangent to the new indifference curve and parallel to the new budget line.
B) tangent to the new indifference curve and parallel to the old budget line.
C) tangent to the old indifference curve and parallel to the new budget line.
D) tangent to the old indifference curve and parallel to the old budget line.
Answer: C

4. If John is relocated to another city with higher living costs and different relative prices of
goods, and his firm increases his salary in the new city so he can afford the same bundle of
goods as in their original city. We can conclude
A) the firm overcompensates him.
B) the firm pays him just the necessary amount to relocate.
C) the firm underpays for his relocation.
D) Not enough information.
Answer: A

5. If a good is an inferior good, then its

A) demand curve will be upward sloping.
B) income effect reinforces the substitution effect.
C) income elasticity is negative.
D) Engel curve cannot be drawn.
Answer: C

6. In response to an increase in the wage rate, the substitution effect will cause a person to
A) supply fewer hours of labor.
B) supply more hours of labor.
C) supply the same hours of labor.

1
D) have a backward bend in her labor supply curve.
Answer: B

7. If a person supplies more hours of labor in response to a wage increase, then

A) the substitution effect is greater than the income effect.
B) the income effect is greater than the substitution effect.
C) the income effect equals the substitution effect.
D) the person is not maximizing utility.
Answer: A

8. Suppose Lisa spends all of her money on books and bagels, and a bagel is an inferior good
for her. When the price of books increases, the
A) consumption of bagels will fall.
B) consumption of bagels will rise.
C) consumption of bagels will not change.
D) Not enough information.
Answer: B

9. When the price of a good changes, the total effect of the price change on the quantities
purchased can be found by comparing the quantities purchased
A) on the old budget line and the new budget line.
B) on the original indifference curve when faced with the original prices and when faced with
the new prices.
C) on the new budget line and a hypothetical budget line that is a parallel shift back to the
original indifference curve.
D) on the new indifference curve.
Answer: A

10. If Bobby thinks that leisure is an inferior good, then his labor supply curve
A) is backward bending.
B) is always negatively sloped.
C) is always positively sloped.
D) does not exist.
Answer: C

11. Sarah and David both have linear demand curves for lemonade. Sarah's demand curve for
lemonade intersects David's demand curve at a price of 50 cents per glass. Sarah's demand
curve is more inelastic than David's. A change in the price of lemonade from 50 cents to 25
cents per glass will
A) decrease Sarah's consumer surplus more than David's.
B) decrease David's consumer surplus more than Sarah's.
C) increase Sarah's consumer surplus more than David's.
D) increase David's consumer surplus more than Sarah's.
Answer: D

12. The graph below shows George's indifference curves and budget lines. From A to B, we
can conclude

2
A) leisure is a normal good.
B) leisure is an inferior good.
C) George will increase his working time with a higher wage.
D) the substitution effect is greater than the income effect.
Answer: A

13. Employing a fixed-weight index like the Consumer Price Index to adjust a person's salary
in response to inflation will overcompensate this person because doing so will allow this
person to
A) buy the same bundle of goods as he did before the inflation.
B) achieve a higher level of utility than he did before the inflation.
C) achieve the same level of utility as before the inflation.
D) buy more of all goods.
Answer: B

14. After Joyce and Larry purchased their first house, they made additional home
improvements in response to increases in income. After a while, their income rose so much
that they could afford a larger home. Once they realized they would be moving, they reduced
the amount of home improvements. Their Engel curve for home improvements on their
current home is
A) negatively sloped.
B) flat.
C) positively sloped.
D) backward bending.
Answer: D

15. The term "inverse demand curve" refers to

A) a demand curve that slopes upward.
B) expressing the demand curve in terms of price as a function of quantity.
C) the demand for "inverses."
D) the difference between quantity demanded and supplied at each price.
Answer: B

16. If the income elasticity of hamburgers is -0.8 for John, then his share of income spent on
hamburgers will ________ when his income increases.
A) increase
B) decrease
C) remain the same

3
D) Not enough information
Answer: B

17. The below figure shows Bobby's indifference map for soda and juice. B1 indicates his
original budget line. B2 indicates his budget line resulting from a decrease in the price of
soda. What change in quantity best represents his income effect?

A) 3
B) 10
C) 15
D) 7
Answer: D

18. If the marginal tax rate rises above t * = 63%, tax revenue will decrease because
A) workers refuse to pay taxes since the tax rate is too high.
B) workers are in the downward-sloping portion of labor supply.
C) workers reduce working hours in response to the wage loss.
D) None of the above.
Answer: C

19. Due to inflation, nominal prices are usually

A) equal to real prices.
B) smaller than real prices.
C) larger than real prices.
D) a constant proportion different from real prices.
Answer: C

20. Suppose a victim of an accident brings the injurer to court. You are hired to determine the
amount of damages. You are specifically asked to find a measure of the amount of money
needed to restore the victim to the position he was in prior to the accident. What welfare
measure will provide the most accurate measure of this amount?
A) compensating variation
B) equivalent variation
C) consumer surplus
D) the loss of utility
Answer: A

B. Analytical Problems (40%, 10 points each)

1. Draw two graphs, one directly above the other. On the upper graph, label the vertical axis
Good X and label the horizontal axis Good Y. On the lower graph, label the vertical axis the

4
Price of good Y and label the horizontal axis Good Y. In the upper graph, show the income
and substitution effects of a decrease in the Price of good Y when Y is an inferior good,
where substitution effect is larger than income effect. Draw the corresponding demand curve
for Good Y in the lower graph.

Ans : Demand curve of goods Y will be negative slope.

2. A consumer has the quasi-linear utility function

U(q1 , q 2 ) = 8q1 0.5 + q 2
Assume p2 = 1 and Y = 100. Suppose p1 increases from 1 to 2, show that the consumer's
compensating variations equal to equivalent variations for such an increase.

Ans :
First, find her demand for good 1:
16
q1 = 2
p1
It is helpful to write her utility in terms of q1 and her expenditures/income:
= 8q1 0.5 + E − p1 q1
When p1 = 1, her demand is q1 = 16. Her utility is then:
= 8(16)0.5 + 100 − 1(16) = 116
When p1 = 2, then q1 = 4. The CV is the amount of additional income needed to achieve the
same utility level with that higher price:
116 = 8(4)0.5 + 100 + CV − 2(4)
Thus, CV = 8.
The EV is found by the equation
8(16)0.5 + 100 − EV − 1(16) = 8(4)0.5 + 100 − 2(4)
Notice this is the same as the equation above so EV = CV = 8.

3. Suppose a person's utility for leisure (L) and consumption (Y) can be expressed as
𝑈(𝑌, 𝐿) = 𝑌𝐿 and this person has no non-labor income. Assuming a wage rate of $10 per
hour, show what happens to the person's labor supply when the person wins a lottery prize of
$100 per day.

Answer: Rearranging yields U = (Y ∗ + 10H)(24 − H) = 24Y ∗ + 240H − Y ∗ H − 10H 2 .

dU
Maximizing utility with respect to H yields dH = 240 − Y ∗ − 20H. Before winning the
lottery, Y ∗ = 0, so H = 12. After winning the $100 per day lottery, Y ∗ = 100, so H = 7.
Winning the lottery reduces this person's quantity of labor supplied by 5 hours when w = $10.

4. Pat eats eggs and toast for breakfast and insists on having three pieces of toast for every two
eggs he eats. Derive his utility function. If the price of eggs increases but we compensate Pat
to make him just as “happy” as he was before the price change, what happens to his
consumption of eggs? Draw a graph and explain your diagram. Does the change in his
consumption reflect a substitution or an income effect?

Ans : Let q1 is the quantity of eggs and q 2 is the quantity of toast.

Utility function will be 𝑈(𝑞1 , 𝑞2 ) = min(3𝑞1 , 2𝑞2 ). If p1 increase, the budget line will rotate
inward. Then, we compensate Pat to make him just “happy” as he was before. His
consumption of 𝑞1 will still the same as shown. There is only income effect and no

5
substitution effect because these two are perfect complements. In other words, Pat will not
substitute toasts with eggs even though the price of eggs increases.

C. Short Answers (10%, 5 points each)

1. Using the Slutsky equation, show under which conditions the compensating variation and
equivalent variation will be closer to each other.

Answer: when the income elasticity is smaller and the budget share is smaller

2. What is the difference between compensated demand curve and uncompensated demand
curve?

Answer: 給分重點：主要差異是有無 hold utility constant

Compensated demand curve: show how quantity demanded changes when price increases,
holding utility constant.
Uncompensated demand curve: show how quantity demanded changes when price increases,
holding other prices, income, and her tastes constant, while allowing the utility to vary

6
 =
190 1
X Islope
(i) Y is an interior goods (IIE) : ISE
M B(z : Pxx + PyY = M
(ii) Decrease in price of Y (Py + PY) PX ↑

(iii) Assume income = M

Effect Decomposition
Y
CE : Pyt :.
(Bt ,
X decrease ,
Y increase Y0Y2Y/ - M

PY Py
↓ IE :: By t
: real income T , It : Y is interior SE -
,
B( : PxX + Py Y = M
↑
Because IIEl
=
TE : : IE l :: when Py ↓ Y will increase IE
Is lope
,

PY

P · Ez

Y
YOY2

Demand fr of Y

Inegative slope
101 Method 1.

0.5
We know : 16) v191 , 92) = 8 9. + 92
(2) P. = 1 , Pa = ) , < = 100

(3) P, increase to 2
, P. = 2

Show CV = EX

(i) Find 21
-
Step 2 -
Expenditure -
Minimization given new price

Min E
-
Step 1
-

Utility -
Maximization (given original price = 29 , + 92
* 0 5
0. 89 ,
.
1 + u = 110 = + 91
89
.

Max v(9 , , 92) = . + 9

0 5
3 + 89 ,
.
. 100 = a1 + 92 L = 291 + 92 + x(116 - -
92)
%.
L = 89 , + 92 + 11100 -
9. -
92 (F . 0 . (

OL 0 .5
(F . 0 . ( = 0 = 2 + x) -
49 , S ...
(4)
091
OL %0 . 5
= 0 = +9 , + x( -
1) ...( )
091 OL
= 0 = 1 + x( -
3) ... (5)
092
OL
= 0 = 1 + x( -
3) ... (2)
Check corner solution
092 OL % 5
(i) i + 191 = 100 , 92 = (
0 = 0 = 116 -
89 ,
.
-
91 ...
16)
OX
OL +
= 0 = 100 -
90092 %.
(3) > i = 8/100 + 0 = 80 +4
OX
14
(ii) i + 191 = 0 92 = 100 from
-0 5 .
,
, 51
: + 9. = 2

> i = 100 +ut

from"
- 0 5
*
.

: + ,
9 /
= :
2 Ji 9 , = 4 ...
bring into 161
solution
,
:. No corner
*
↑ = T ,
a , = 16 ...
bring into 131 110 = 85 + 92 ,
92
*
= 100

*
100 = 10 + 92 , 92 = 84 .. E(9 , *, &2 * ) = 2(4) + 100 = 108
* *
: 191 *, 92 ) = 8570 + 84 = 110
(V E 108
= -
M = -
100 = 8
,
(ii) Find El
-
Step 1
-

Utility -
Maximization (given new price
-
Step 2 -
Expenditure -
Minimization given old price
0.
Min E = 91 + 92
Max v(9 , , 92) = 89 . + 9
* 0 5
108 89 ,
.

3 . + 100 = 291 + 92
1 . + u = = + 91

%. 0 5
89 .
.

L = 89 , + 92 + 11100 -
29. -
92 L = 91 + 92 + x(108 - -
9)

(F . 0 . ( (F . 0 . (

OL OL 0 .5
= 0 = +9 ,
-0 . 5
+ x( -
2) ...
(1) = 0 = 1 + x) -
49 - S ... 4)
091 091

OL OL
= 0 = 1 + x( -
3) ... (2) Check corner solution = 0 = 1 + x( -
3) ... (5)
092 092
(i) i + 191 = 50 , 92 = 0
OL OL % 5
= 0 = 100 -
90092 %.
(3) (i = 8/50 + 0 =
8/50in * = 0 = 108 -
89 ,
.
-
92 .
16)
OX OX
(ii) i + 191 = 0 , 92 = 100

+ut 14
i = 100 from 9 ..
0 5

from "
-0 5 > .

. : + :
: + 9, = 2 ,1
:. No corner solution
*
= J 9
* - = T a , = 16 ...
bring into 161
2
,
, = 4 ...
bring into 13 ,

* *
100 = 2(4) + 92 , 92 = 92 108 =
8/0 + 92 ,
92 = 76

: u
*
19 1 *, 92 )
*
= 85 + 92 = 108 .. E(9 . *, &2 *
) = 10 + 76 = 92

EX = M -
E = 100 -
92 : 8 : (1
,
Method .
I

nas =
/g . D . P . Mid gip , Pudp Ev =
jap , Pull

"
-
Step 1 -
Find a, and a ,

2
(i) Solve 9 (ii) Solve 9
0.5
Max u(9 ,, 92) = 89 , + 92 Min E = P , 91 + P292

1 +100
. = P , 9, + P292 1 . tv = 89 ,
0 . 5
+ 92
%.5 %
· 2 = 89 , + 92 + 1/100 -
p , 9, -
P292) -2 = P , 91 + P29 + 65 -
89 , -
92

(F , 0 , / (F , 0 , /

OL OL Pl
: =
0 5 -0
5 from
49 ,
-0
+ x) P, ) 49 ,
.

= 0 = -
.., ) = 0 = P, + x) -
49 ,
.

.... (4)
89 89 PL

: PC is fixed at
Oh Oh
= 0 = 1 + x) -
Pz) ..
(2) = 0 = P2 + X) -
1) . "
(5) 4 10
892 892 ..
= P, 9
p, z

Oh Oh 0 5
= 0 = 100 -
p , 9 . -P292 : "
13) = 0 = = -
89 ,
.
-
92 ...
10)
892 892

Pl
;"
-0 5
from : 49 ,
.

-
PL

: PC is fixed at
4 10
a ,*=
"Tai = P ,,
p, z

-
Step 2 - Discuss Als ,
Cu , Ev

=
10 .. (V = Acs = EU 191 is neutral goods (
: (i) 9 , = 9
2
p,
89 ,
= c =
jad
(ii) = 0 91 is independent on
utility
gy
(1 %
,

= = 8 -
1161 = 8 = EU = c
150
We know : <s UCY , L) = YL
, Consumption
(2) wage rate = $10 per hour

Original Equilibrium New

Equilibrium
Max U ( Y 1) = YL Max US Y , 1) = YL
,

work hours
3 .
5 Y = 10 (24 -
1) 3 .
5 Y = 10(24 -
1) + 100

labor
non-labor income/Lottery
income per day
x = Y + x(10(24 -
2) -
Y) + 100 Y)
x = Y( + x(10(24 -
2) -

CF O C( . .
CF O C(
. .

OL
= 0 = n + 4) -
1) ...
() OL
8 Y
= 0 = n + x) -
1) ...
(4)
8 Y
14) t ↓
OL
OL
from : =
= 0 = Y + x) -
10) ...
(2) 15( Y 10
OL
= 0 = y + x( +
10) ...
(5)
OL
:. = 101 bring into 33
OL
10(24 1) Y OL
= 0 = - -

= 0 = 10(24 -
1) + 100 -
Y 0 = 340 - 101 -
y = 348 -
2Y
OX
OX
= 240 - 101 -
Y ...
(3) = 340 - 102 -
Y ... 101 y = 170 . = 17
7
124 -
11) = 7
↓
from
:"
,
=
10

:. = 101 bring into 33

0 = 240 - 101 -
y = 248 -
2Y
work hours decrease by 112-1) = 5 his

Y
*
= 120 .
1
*
= 12
consumption increase by 1170-110) = 50 units

*
124-1 ) : 12
Let 9, be
egg , he be toast

E= 2q 3 =

is U = min 1391 292) Opt pt

,
2

& As the when the rise , he still

graph ,
price of the egg
Ez
purchase the same bundle of goods as before , So his consumption
of a will be the same,

3t
e 22
=
& There is only income effect and no substitution effect
·
Il

Gr
Since two goods are
perfect complement,

3 pt
1601)
((u + sky Equation :

total effect
= income effect + substitution effect
*
> 3 = 3 + 1 -

04
of uncompensated demand fr
3 :
elasticity
3*: elasticity of compensated demand to

O : the share of the budget spent on the goods

3 : income elasity

when 3 , 3 *, CV will be close to EX

that is , ·
O -0 ,
income elasticity approaches to zero

In other word , goods tend to be neutral goods