February 7, 2008 Name___________________________

Midterm I
Economics 401

Assume throughout the exam that preferences are strictly monotonic and
strictly convex and that indifference curves are not kinked UNLESS the
question tells you otherwise.

The number in brackets [] before the text of each question refers to

its point value. There are 30 questions worth 2.5 points each, 10
questions worth 4.5 points each, 10 questions worth 7 points each, and
10 questions worth 11 points each.

1. [7] If Q = Ap-b, what is the elasticity of demand?

A. -b
B. -A
C. Depends on the price
D. -A/b

2. [2.5] When an insurance company offers fair insurance

A. on average, the insurance company will make no money from the

contract
B. the price of transferring a dollar from one state to the other
reflects the true relative probabilities of those states
C. a risk averse person will buy full insurance
D. all of the above

3. [11] Ginger has an income of 100 which she can spend on food (F) or
shelter (S). She has utility function U = F3S2. Ginger's optimal
consumption of F is 10 units. What is the price of food?

A. 4
B. not enough information
C. 6
D. 10

4. [2.5] By selecting the bundle where MRS = MRT, the consumer is saying

A. "My marginal utility of the last unit purchased of each good is

equal."
B. "I am willing to trade one good for the other at the same rate that
that is determined by the market."
C. "I will set the amounts spent on all goods consumed to be equal."
D. All of the above.

Page 1, v3
5. [2.5] Moving up an Engel curve, what is happening to prices?

A. decreasing
B. held constant
C. could be increasing, decreasing, or held constant
D. increasing

6. [7] After careful study, researchers have estimated a utility function

for cigarettes (C) and food (F), and determined that the compensated
demand functions are C=(U*pF)/2pC(1/2) and F=(3U*pC)/pF(1/2), where U
is the utility level. How much must a consumer with this utility
function spend to achieve a utility level of 2 when the price of
clothes is 4 and the price of food is 9?

A. 120
B. 90
C. 60
D. 30

7.
$ per cup

cups of coffee per day

[2.5] Todd’s daily demand curve for cups of coffee is shown in the
above figure. What is Todd’s marginal willingness to pay for his 4th
cup of coffee?

A. $4
B. $3
C. $2
D. $1

8. [2.5] We derive a worker’s (uncompensated) labor supply curve using

A. the worker’s Engel curve for leisure.

B. the worker’s uncompensated demand curve for leisure.
C. the worker’s Hicks demand function for leisure.
D. the worker’s expenditure function.

Page 2, v3
 9. [4.5] The figure below depicts various indifference curves for utility
over two bets A and B. (The indifference curves are the thick solid
black lines; the dashed line is the certainty line.) Which indifference
curve(s) is consistent with risk-loving preferences?

A A
I II

B B
A A
IV
III

B B

A. I and IV
B. III and IV
C. IV only
D. II and III

10. [4.5] If Bobby thinks that leisure is an inferior good, then his labor
supply curve is

A. always negatively sloped.

B. backward bending.
C. always positively sloped.
D. partly positively and partly negatively sloped.

11. [2.5] Some good must be normal, because otherwise preferences violate
which property?

A. more is better
B. strict convexity
C. transitivity
D. completeness

Page 3, v3
12. [2.5] The marginal rate of transformation of y for x represents

A. -Px/Py (where Px is the price of x and Py is the price of y)

B. the slope of the budget constraint
C. the rate at which the consumer must give up y to get one more x
D. All of the above

13. [4.5] Suppose that 100 people were asked to imagine that they’d been
infected with a potentially fatal disease for which a costly cure
exists, and then asked how much they’d be willing to pay for the cure
above and beyond its market price in dollars. Their average answer was
$250,000. Economists refer to this monetary amount, $250,000, as:

A. Compensating variation (CV)

B. Equivalent variation (EV)
C. Consumer surplus (CS)
D. Consumer preferences (CP)

14. [4.5] Between 1971 and 2006 the United States from time to time imposed
quotas or other restrictions on importing steel. Suppose both the
domestic and the foreign supply curves of steel for sale in the United
States are upward-sloping straight lines. What is the effect of a U.S.
quota on steel of Q*>0 on the equilibrium in the U.S. steel market?

A. Equilibrium price will decrease.

B. Equilibrium price will increase.
C. Equilibrium quantity will decrease.
D. It cannot be determined.

15. [2.5] A Consumer Price Index adjustment overcompensates for inflation

because it assumes that

A. there is no income effect when relative prices change.

B. the substitution effect is zero when relative prices change.
C. that at least one good is inferior.
D. that the substitution effect may offset the income effect.

16. [2.5] Assume the market for milk is competitive. The government has
decided to levy a $0.15 tax per gallon of milk. You, as an economist
(and a consumer of milk), get to decide whether the tax will be
collected from the producers or from the consumers. You

A. prefer to tax the consumers.

B. need to know the elasticity of demand for milk.
C. prefer to tax the producers.
D. don’t care where they collect the tax.

17. [11] Suppose that, in the U.S., the average marginal income tax rate,
t, is 20%. Then (1-t)/t = 4. What must be true about labor supply, for
an increase in the tax rate to mean an decrease in tax revenue?

A. the elasticity of labor supply must be less than 4.

B. labor supply is inelastic.
C. the elasticity of labor supply must be greater than 4.
D. U.S. workers are on the backward-bending portion of their labor
supply curves.

Page 4, v3
18. [2.5] Assume that for all consumers blue pencils and red pencils are
substitutes, and also normal goods. If the largest factory producing
red pencils is struck by lightning, decreasing the supply of red
pencils, the market equilibrium for blue pencils will

A. increase in quantity, but the effect on price is ambiguous.

B. decrease in price but increase in quantity.
C. increase in price and quantity.
D. increase in price, but the effect on quantity is ambiguous.

19. [4.5] According to the Wall Street Journal, a recent salary increase
for economics professors resulted from an outward shift in the demand
curve for academic economists due to the increased popularity of the
economics major, while the supply curve of Ph.D. economists did not
shift and the quantity supplied did not change. If we assume that more
people will decide to enter doctoral programs in economics as a result
of the higher salaries, how would such entry affect the long-run price
elasticity of supply?

A. It would decrease from a strictly positive number to zero.

B. It would increase from zero to a strictly positive number.
C. It would increase from one to an elasticity greater than one.
D. It would decrease from an elasticity greater than one to one.

20. [2.5] Suppose bet B pays 10% more in the good state and 10% less in the
bad state than bet A and both states are equally likely. Then it must
be the case that

A. B has a lower risk premium than A for a risk neutral agent

B. B has a higher expected utility than A
C. B has a lower expected utility than A
D. B has a higher risk premium than A for a risk averse agent

21. [2.5] Which of the following is NOT indicative of strong market forces?

A. zero transaction costs

B. zero taxes
C. perfect information
D. price-taking consumers

22. [2.5] If a good is normal, then an increase in income will

A. cause a movement downwards along the demand curve

B. shift the demand curve left
C. shift the demand curve right
D. cause a movement upwards along the demand curve

23. [4.5] Consumers will bear the full burden of a specific tax if:

A. demand is perfectly inelastic or supply is perfectly elastic.

B. demand is perfectly elastic or supply is perfectly inelastic.
C. demand is perfectly inelastic or supply is perfectly inelastic.
D. demand is perfectly elastic or supply is perfectly elastic.

Page 5, v3
24. [2.5] Assume the demand curve for chips is downward sloping and the
supply curve for chips is upward sloping. If chips and salsa are
perfect complements, a decrease in the price of salsa will result in

A. an upward movement along the demand curve for chips.

B. a shift left in the demand curve for chips.
C. a shift right in the demand curve for chips.
D. a shift right in the supply curve of chips.

25. [4.5] In 2006, the marginal tax rate on a single person making between
$30,651 and $74,200 was 25%. Suppose the elasticity of labor supply is
2 and suppose demand for labor is horizontal. The marginal tax rate can
then be increased up to 33.3% without decreasing tax revenues. Suppose
now that labor demand is downward sloping. How much can we increase the
marginal tax rate, without decreasing tax revenues, compared to the
case with horizontal labor demand?

A. less than 33.3%

B. exactly 33.3%
C. more than 33.3%
D. none of the above.

26.
H

F
BL1
BL2

[4.5] Kate is considering two different job offers in two different

cities. Each job will give her a different income, but each city has
different prices. Kate consumes only food (F) and housing (H). The
income from the first job offer and the prices in the first city lead
to Kate having a budget line BL1 in the figure above. The income from
the second job offer and the prices in the second city would lead to
the budget line BL2. One of Kate's indifference curves is also shown in
the figure. Which of the following is true?

A. Kate cannot compare the two job offers.

B. Kate prefers job offer 1 to job offer 2.
C. Kate prefers job offer 2 to job offer 1.
D. Kate is indifferent between her two job offers.

Page 6, v3
27. [11] Rasheed has the utility function U(q1,q2)=q13q2. For p2=1 and a
utility level of 2, what is Rasheed’s compensated demand function for
q1?

A. (2/p1)(1/2)
B. (6/p1)(1/4)
C. 3/p1(1/2)
D. 3/(2p1)

28. [2.5] If Chauncey spends all his money on basketballs and sneakers, and
the price of sneakers increases, then what can you conclude about the
substitution and income effects for sneakers?

A. substitution effect is positive, income effect is negative

B. substitution effect is negative, income effect is negative
C. substitution effect is positive, income effect is ambiguous
D. substitution effect is negative, income effect is ambiguous

29. [7] Rodney has the utility function U=x1+2x2, and faces prices p1=1 and
p2=1. Which figure depicts his Engel curve for x1?

Y A. Y B.

x1 x1

Y Y D.
C.

x1 x1

A. A
B. B
C. C
D. D

30. [7] Suppose that a worker has the utility function U = YN, where Y is
income and N is leisure. If Y = wH and N = 24-H, where w = wage, what
is this worker’s labor supply function, H*? (Hint: Try writing the
utility function as a function of H only and then solving the problem.)

A. H* = 8
B. H* = 12
C. H* = 12w
D. H* = 8w

Page 7, v3
31. [11] Suppose MARGINAL utility for good x is given by (x+a).5, where "a"
is a parameter. This implies

A. the decision maker is risk averse for all values of a>0.

B. the decision maker is risk aversion for some values of a>0.
C. the decision maker is risk loving for all values of a>0.
D. nothing about his risk attitude.

32. [11] If a consumer's utility function is U(q1,q2)=min{q1,q2}, what is

the expenditure function E(p1,u) for q1? In the answer choices below, u
is a fixed level of utility.

A. u*(p1+p2)
B. depends on whether p1>p2
C. (p1*u)(1/2)
D. p1*u

33. [2.5] Granny spends 75 percent of her budget on health care and 25
percent on food. If the prices of both goods rise, and Granny’s income
is adjusted using a fixed-weight index like the Consumer Price Index
(the weights equal her original budget shares), then after the price
change Granny is strictly better off

A. ONLY if the relative price of health care has fallen

B. if the relative price of health care has changed
C. ONLY if the relative price of health care has risen
D. ONLY if the relative price of health care has remained constant

34. [2.5] We measure consumer welfare in units of

A. dollars
B. percent of GDP
C. elasticity
D. utils

35. [2.5] Suppose bet B pays 10% more in the good state and 10% less in the
bad state then bet A and both states are equally likely. Then it must
be the case that

A. B has a higher expected value than A

B. B has a lower expected value than A
C. B has a higher variance than A
D. B has a lower variance than A

36. [2.5] Which property of preferences implies that indifference curves

cannot be thick?

A. Completeness
B. More is better
C. Transitivity
D. All of the above

Page 8, v3
37. [2.5] Which of the following represents a true statement about the
compensated demand curve?

A. reflects substitution effect only; must be downward sloping

B. reflects substitution effect only; can be upward sloping
C. reflects income and substitution effects; must be downward sloping
D. reflects income and substitution effects; can be upward sloping

38. [2.5] In order to offset the harm to a consumer from a price increase,
we can give her an amount of money called Hicks compensation. What MUST
be true about this compensation?

A. It moves that consumer to a new indifference curve.

B. It allows her to afford the initial optimal bundle at the old
prices.
C. It keeps that consumer on her original indifference curve at the new
prices.
D. It would be refused by the consumer if actually offered.

39. [2.5] The risk premium of a bet is defined as

A. the amount of utility a risk-averse person gives up by taking the

bet
B. the variance of the payoffs given by the bet
C. the amount of money a risk averse person would pay to avoid the risk
D. the amount of money a person would pay to take the bet

40. [2.5] Gavin purchased a pair of vintage sneakers on WeeBay for $25. On
his first night wearing them out on the town, someone offered him $100
for the sneakers. Gavin refused. One can conclude that Gavin’s consumer
surplus from the sneakers is

A. less than $25.

B. at least $100.
C. at least $75.
D. $125.

41. [11] The demand for apples is given by QD=1-3p2-2pb+½Y, where p is the
price of apples, pb is the price of bananas, and Y is income. The
supply of apples is given by QS=5p–pb. By how much (approximately)
will the equilibrium price for apples increase with a $4 increase in
income if the current price of apples is $0.50?

A. 1
B. 2.5
C. 4
D. .25

Page 9, v3
42. [7] The substitution elasticity of demand is the same for beans, rice,
meat, and wood. Which good is most likely to be a Giffen good?

Budget Share Income Elasticity

Beans .1 -.5
Rice .2 -.5
Meat .1 1.6
Wood .2 -.2

A. beans
B. wood
C. meat
D. rice

43. [11] Suppose the demand curve for movie tickets has unitary price
elasticity and the supply curve is perfectly price elastic. If 2
million tickets are currently sold at a price of $5, how much tax
revenue could the government generate from a $0.50 specific tax?

A. $2 million
B. $0.9 million
C. $1 million
D. $2.5 million

44. [2.5] When Matthis got a promotion at work, his wage increased from $11
to $18/hour. He then decided to work only 38 hours per week, instead of
his usual 40 hours per week. What can we say about Matthis’s current
value of his leisure time?

A. Leisure is a normal good.

B. Leisure is an inferior good.
C. Leisure is overrated.
D. Leisure is a Giffen good.

Page 10, v3
45. food

100

50 75 150 housing

[2.5] In the above figure, income is held constant, and three budget
lines and indifference curves are shown. If income is known, then you
could graph three points on the:

A. demand curve for housing

B. Engel curve for housing
C. demand curve for food
D. Engel curve for food

46. [2.5] Having strictly convex preferences implies that the absolute
value of the MRS of y for x

A. is decreasing as x increases.
B. is constant as x increases.
C. is increasing as x increases.
D. None of the above.

Page 11, v3
47. y

D
B

[2.5] The following 2 questions concern the figure above. The line
drawn is a consumer's budget line for x and y. Which of the following
bundles is least expensive?

A. A
B. B
C. C
D. D

48. [2.5] Of the bundles A, B, and C in the figure above, which is the most
preferred?

A. A
B. B
C. C
D. not enough information

49. [2.5] In the figure above, if the consumer's optimal choce is the point
B, which of the following COULD be true about the MRS at the point B?

A. MRS = -1/2
B. MRS = -2
C. MRS = -4
D. none of the above

Page 12, v3
50. y

A
10

10 x

[4.5] The following two questions concern a consumer with preferences

over x and y and the budget line drawn above. Note that, for this
consumer, px = py.

If the consumer's optimal choce is the point A (where x=0), which of

the following COULD be true about the MRS of y for x at the point A?

A. MRS = -4
B. MRS = -1/2
C. MRS = -2
D. none of the above

51. [7] The following 2 questions concern Toby who has an income of 60 and
faces a price of 1 for good x and a price of 2 for good y.

Suppose Toby's utility for x and y is given by U = min{2x,y}. What is

Toby's optimal consumption bundle?

A. x = 20, y = 40
B. x = 12, y = 24
C. x = 16, y = 22
D. x = 12, y = 6

52. [11] Now suppose Toby has utility function U = ln(x) + y. Now what is
Toby's optimal consumption bundle?

A. x = 2, y = 29
B. x = 24, y = 18
C. x = 20, y = 20
D. x = 10, y = 25

Page 13, v3
53. [7] The next two questions concern Fred, a farmer who grows vegetables
on land that is close to a river. The river occasionally floods in the
spring with disastrous consequences. If there is no flood, the
production will be high and the vegetables will sell for $2500. If
there is flood, then what is left of the vegetables will be worth only
$100. Fred can buy flood insurance at a cost of $0.10 for each $1 worth
of coverage, i.e., if Fred buys ten units of insurance, he has to pay
$1 upfront and receives $10 if a flood occurs. Fred thinks that the
probability of a flood is 10%. Letting Y denote income, Fred's utility
function is U(Y)=Y(1/2).

What is Fred's expected income if he does not buy insurance?

A. $2240
B. $2260
C. $2290
D. None of the above

54. [11] At his optimal choice, how many units of insurance will Fred
purchase?

A. 2400
B. 2100
C. 2260
D. none of the above

Page 14, v3
55.
U

U(W)

Bet A
Bet B

20 30 50 70 80 W

[2.5] The next two questions concern the diagram above, which shows a
utility function and two bets. Bet A pays $30 in state 1 and $70 in
state 2. Bet B pays $20 in state 1 and $80 in state 2. Both states are
equally likely.

It must be that

A. the agent is indifferent between bet A and bet B

B. it is unclear whether the agent prefers Bet A or Bet B
C. the agent prefers Bet B to bet A
D. the agent prefers Bet A to bet B

56. [4.5] Refer again to the figure above. Which of the following must be
FALSE?

A. Both bets give the same expected wealth

B. The agent prefers $50 for sure to either bet
C. Bet B has a lower risk premium than Bet A
D. Bet B has higher variance than Bet A

57. [7] The following 2 questions concern Jackie, who has income Y, faces
prices p1 and p2, and has a Cobb-Douglas utility function:
U = q1a q2(1-a). Assume 0<a<1.

What is Jackie's marginal rate of substitution?

A. -((1-a)/a)(q2/q1)
B. -(a/(1-a))(q1/q2)
C. -(q1/q2)
D. -(a/(1-a))(q2/q1)

Page 15, v3
58. [7] What is Jackie's optimal consumption of q2?

A. aY/p2
B. (1-a)Y/p2
C. aY/p1
D. (1-a)Y/p1

59. [7] Jen has a concave utility function U(W)=W(1/2). She faces a bet
that will pay either $400 or $144 with equal probability. Assume Jen
has no other wealth. She would be indifferent between this bet and a
certain payment of

A. $304
B. $272
C. $256
D. $288

60. [11] Jen has a concave utility function U(W)=W(1/2). She faces a bet
that will pay either $400 or $144 with equal probability. Her risk
premium for this bet is

A. $16
B. $32
C. $0
D. $64

Page 16, v3
 Answer Key for Test "Econ 401 W08 MT1.tst", 2/5/2008
No. in No. on
Q-Bank Test Correct Answer
1 1 1 A
5 10 2 D
2 6 3 C
2 3 4 B
3 3 5 B
3 12 6 B
4 12 7 C
4 3 8 B
5 18 9 C
4 17 10 C
3 7 11 A
2 2 12 D
4 13 13 C
1 5 14 D
4 14 15 B
1 8 16 D
4 8 17 C
1 9 18 C
1 6 19 B
5 4 20 D
1 2 21 B
3 6 22 C
1 7 23 A
1 3 24 C
4 10 25 C
2 8 26 C
3 11 27 B
3 4 28 D
3 13 29 D
4 7 30 B
5 11 31 C
4 15 32 A
3 5 33 B
4 11 34 A
5 3 35 C
2 1 36 B
3 9 37 A
4 2 38 C
5 5 39 C
4 1 40 C
1 11 41 D
3 15 42 D
1 13 43 B
4 5 44 A
3 1 45 A
2 4 46 A
2 9 47 C
2 10 48 D
2 12 49 D
2 11 50 B
2 13 51 B
2 14 52 A
5 13 53 B
5 14 54 A
5 16 55 D
5 17 56 C
2 15 57 D
2 16 58 B
5 8 59 C
Page 1, v3
 Answer Key for Test "Econ 401 W08 MT1.tst", 2/5/2008
No. in No. on
Q-Bank Test Correct Answer
5 9 60 A

Page 2, v3