Econ 360

Midterm 1

Oct 8th, 2009

You are expected to do your own work and not to consult notes, books, or other resources. The exam is scheduled for 90 minutes. There are 5 questions for a total of 90 points (one point per minute.) Approximately one quarter of the points are at each star-level (0,1,2,3.) Good Luck!

1. Your professor’s demand for ice-cream cones is given by the following formula: D =1/2I − 2p, where I is my (weekly) income in dollars and p is the price of an ice-cream cone. (a) (5 points) Draw my demand curve, supposing that my income is $100. When the price is $10, how many ice-cream cones do I buy? Show this on your graph. For parts b-d, assume my income is $100 and the price is $10. (b) (5 points) * Find my elasticity of demand. Is my demand price elastic or inelastic? (c) (5 points) ** If the price were to go up, would I spend more or less on ice-cream cones? Why? (d) (5 points) * Find my income elasticity of demand. Is ice cream inferior or normal, and, if normal, is it a luxury or a necessity? A friend of mine has the same demand curve for ice-cream cones. Assume that each of us have an income of $100. Suppose that the two of us are all the people who buy ice-cream cones. (e) (5 points) What is the market demand curve for ice-cream cones? Write the formula and draw a graph. (f) (5 points) ** Is the market demand more elastic, less elastic, or as elastic as my demand alone? WHY? 2. Bus trips and taxi rides. George rides into town sometimes and either takes a taxi x or the bus y. Unfortunately, he is not a student so he has to pay for the bus. His utility function for the two is: u(x, y) = xα y 1−α where α = 2 . The bus costs $1 and taxi rides cost $4. 3
2 (a) (10 points) * Suppose α = 3 . George used the taxi four times and the bus twice. Is George optimizing? Should he use the bus more, or the taxi more? WHY?

(b) (10 points) ** Suppose his travel budget is $48 per month. What is his optimal choice (x , y )? How many trips to work does that give him?

Draw his indifference curves for a case in which he strictly prefers the first restaurant. Make sure to label her income in each period. 1). (10 points) *** Alice. Is it possible that she will become a saver? Argue ‘yes’ or ‘no’ using a graph. 2. Suppose the price of consumption today is 1 and the agent can save or borrow at rate r. that it’s possible)? If you think it’s true. Frank likes going out to eat at restaurants but dislikes cigarette smoke. c2 ). (c) (5 points) * Suppose the interest rate falls. Let the two periods of time be called t = 1. including the budget line and the optimal indifference curve. but has bad food. Consider the two-period consumption model discussed in class. Suppose food and smoke are the only two goods. and the food is much better. Consumption today. and for each t. and let ct be her consumption in period t. (b) (5 points) Show on a graph a possible optimal (c1 . use a graph to demonstrate why it’s true. in period 2? Suppose the agent is a borrower. the non-smoker. Claim: When the price of x-ray machines falls. Suppose there are two goods. Suppose the interest rate is some value r ∈ (0. 5. (a) (5 points) Suppose the agent spends all his money for some bundle (c1 . y ) at current prices. If you think it’s false. c2 ). Suppose that x-ray machines are a normal good for Alice. (e) (5 points) *** Suppose I2 increases. Page 2 . Is it possible that she will become a saver? Argue ‘yes’ or ‘no’ using a graph. (5 points) ** Frank. 4. If she purchased one fewer unit of c1 . let It be the agent’s income in period t. (d) (5 points) *** Suppose I1 increases.3. Is it possible that she will become a saver? Argue ‘yes’ or ‘no’ using a graph. how many units of consumption could she get in exchange. x-ray machines and yellow crayons. Suppose Frank had to choose between two restaurants: the first is non-smoking. use a graph to show why it’s false. consumption tomorrow. and Alice buys her optimal bundle (x . Do you think that claim is true (that is. The second allows smoking. it is possible that also x falls.