Quiz1 Review

Note: Please verify answers are correct with AA in case of any doubt.

Q1. What happens to equilibrium price and quantity if:

• Demand curve shifts outwards (demand increases) & Supply curve shifts outwards (supply
increases)
o Q increases, P uncertain
• Demand curve shifts outwards (demand increases) & Supply curve shifts inwards (supply
decreases)
o Q uncertain, P increases
• Demand curve shifts inwards (demand decreases) & Supply curve shifts outwards (supply
increases)
o Q uncertain, P decreases
• Demand curve shifts inwards (demand decreases) & Supply curve shifts inwards (supply
decreases)
o Q decreases, P uncertain

Q2. Suppose the demand curve is given by:

𝑄 = 100 − .5𝑃

• What is the price elasticity of demand when price is 50

𝑝 50
o 𝑒 = 0.5 ∗ 𝑞 = 0.5 ∗ 75 = .33
• Beginning at a price of 50, how can TR be increased?
o Since e<1 => TR will increase as Price is increased
• At what price is the demand curve unit elastic?
𝑝
o 𝑞 = 2 or 𝑞 = 50, 𝑝 = 100

Q3. Compare a good which is a necessity to one which is discretionary. Which demand is more price
elastic?

• Discretionary good will be more price elastic

Q4. What assumptions do we make about preferences?

• Complete, transitive and more is always better

Q5. Define a utility function and indifference curve.

• Utility is the numerical score representing the satisfaction that a consumer gets from a given
market basket.
• An Indifference curve is a curve representing all combinations of market baskets that provide
a consumer with the same level of satisfaction.

Q6. Define MRS. How does it related to MU.

• Marginal Rate of Substitution (MRS) is the maximum amount of a good that a consumer is
willing to give up in order to obtain one additional unit of another good.
 𝑀𝑈
• 𝑀𝑅𝑆 = 𝑀𝑈𝑥
𝑦

Q7. What is the MRS for the following utility functions:

• 𝑢(𝑥, 𝑦) = 𝑥𝑦
𝑦
o 𝑀𝑅𝑆 = 𝑥
• 𝑢(𝑥, 𝑦) = 𝑥 𝑎 𝑦 𝑏
𝑎𝑦
o 𝑀𝑅𝑆 =
𝑏𝑥
• 𝑢(𝑥, 𝑦) = 𝑥 .5 𝑦 .5
𝑦
o 𝑀𝑅𝑆 = 𝑥
• 𝑢(𝑥, 𝑦) = 𝑎𝑥 + 𝑏𝑦
𝑎
o 𝑀𝑅𝑆 = 𝑏
• 𝑢(𝑥, 𝑦) = 2𝑥 + 3𝑦
2
o 𝑀𝑅𝑆 =
3

Q8. What is the budget line if 𝑃𝑥 = 5; 𝑃𝑦 = 10; 𝐼 = 100

• What is the slope of the budget line?

o -0.5
• How does the budget line change if 𝑃𝑥 = 7.5
o Rotates inwards keeping y-intercept the same
• How does the budget line change if 𝑃𝑦 = 7.5
o Rotates outwards keeping x-intercept the same
• How does the budget line change if 𝑃𝑥 = 7.5, 𝑃𝑦 = 7.5
o Both intercepts change
• How does the budget line change if I=200
o Parallel shift outwards

Q9. Suppose 𝑢(𝑥, 𝑦) = 10𝑥𝑦 and 𝑃𝑥 = 5; 𝑃𝑦 = 10; 𝐼 = 100. Find the consumers optimal
consumption bundle and level of utility
𝑦 1
• MRS = Price Ratio or 𝑥 = 2 or 𝑥 = 2𝑦
• BL: 𝑦 = 10 − .5𝑥
• Combining the two: y=5, x=10 and u=500

Q10. Suppose 𝑢(𝑥, 𝑦) = 10𝑥𝑦 and 𝑃𝑥 = 7.5; 𝑃𝑦 = 10; 𝐼 = 100. Find the consumers optimal
consumption bundle and level of utility
𝑦 4
• MRS = Price Ratio or 𝑥 = .75 or 𝑥 = 3 𝑦
• BL: 𝑦 = 10 − .75𝑥
• Combining the two: y=5, x=6.33 and u=10*5*6.33

Q11. Suppose 𝑢(𝑥, 𝑦) = 10𝑥 + 5𝑦 and 𝑃𝑥 = 5; 𝑃𝑦 = 10; 𝐼 = 100. Find the consumers optimal
consumption bundle and level of utility

• MRS = 2 while Price Ratio = .5 => corner solution

• Consume only 20 units of x-good and get u=200
 Q12. Suppose 𝑢(𝑥, 𝑦) = min⁡{𝑥, 2𝑦} and 𝑃𝑥 = 5; 𝑃𝑦 = 10; 𝐼 = 100. Find the consumers optimal
consumption bundle and level of utility

• Preferred combinations of the two goods are such that x=2y

• BL: 𝑦 = 10 − .5𝑥
• Hence, y = 5, x=10 and utility =10

Q13. Define an Engel curve. Why is it backward bending?

• The Engel Curve represents the relation between demand for a good and income
• Backward bending for inferior goods

Q14. Find the Laspeyres and Paasche price index

Price 2000 Qty 2000 Price 2010 Qty 2010

Apple Rs 20/kg 10 Kg Rs 20/kg 5 Kg

Banana Rs 15/kg 5 Kg Rs 25/kg 10 Kg

Q15. Each consumer has an individual demand curve where 𝑞 = 100 − 𝑝. The supply curve is given
by 𝑄𝑠 = 𝑝

• Find the market demand curve if there are 10 such consumers

o Market demand: 𝑄𝑑 = 1000 − 10𝑝
• Find the market equilibrium price and quantity.
o 𝑄𝑑 = 𝑄𝑠 ⁡𝑜𝑟⁡1000 − 10𝑝 = 𝑝⁡𝑜𝑟⁡𝑝 = 90.90
• What is the consumer surplus at equilibrium?
1
o 𝐶𝑆 = 2 ∗ (100 − 90.90) ∗ 90.90

Q16. You estimate market demand to be 𝑄 = 100 − .5𝑃 + .1𝐼. Suppose Income is 1000 and price is
50.

• What is the price elasticity of demand?

o 𝑄 = 200 − .5𝑃
50
o 𝑒 = .5 ∗ 175
• What is the consumer surplus?
1
o 𝐶𝑆 = 2 ∗ (100 − 50) ∗ (175)