Microeconomics Theory and Applications With Calculus 3rd Edition Perloff Test Bank 1

Test Bank for Microeconomics Theory and
Applications with Calculus 3rd Edition Perloff

0133019934 9780133019933
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Microeconomics: Theory and Applications with Calculus, 3e (Perloff)

Chapter 5 Consumer Welfare and Policy Analysis
5.1 Consumer Welfare
1) Mister Jones was selling his house. The asking price was $220,000, and Jones decided he would take no
less than $200,000. After some negotiation, Mister Smith purchased the house for $205,000. Smith's
consumer surplus is
A) $5,000.
B) $15,000.
C) $20,000.
D) not able to be calculated from the information given.
Answer: D
Topic: Consumer Welfare
Status: Old
2) Shin's uncompensated demand for widgets is given by Q = 10/p. According to this demand, Shin's
Marginal Willingness to Pay function is
A) 10/Q.
B) 10/p.
C) 10Q.
D) -10/p2.
Answer: A
Status: Old
3) Jeong's uncompensated demand for gizmos is given by Q = 30 - 2p. Jeong's marginal willingness to pay
1
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function is
A) 30-2p.
B) 15-.5Q.
C) 30-2Q.
D) -2.
Answer: B
Status: Revised
4) You enter a store and buy a bottle of soda. Do you usually receive consumer surplus?
A) Yes, because you wouldn't buy the soda if your willingness to pay would be less than the price.
B) Yes, because you are thirsty.
C) No, because you value other drinks more.
D) No, because you have less money after the transaction.
Answer: A
Status: Old
2
5) 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
C) positive
D) negative
Answer: A
Status: Old
6) Mary purchased a stuffed animal toy for $5. After a few weeks, someone offered her $100 for the toy.
Mary refused. One can conclude that Mary's consumer surplus from the toy is
A) less than $5.
B) at least $95.
C) at least $100.
D) $105.
Answer: B
Status: Old
7) Joe's demand for spring water can be represented as p = 10 - Q (where p is measured in $/gallon and Q
is measured in gallons). He recently discovered a spring where water can be obtained free of charge. His
consumer surplus from this water is
A) $0.
B) $50.
C) $100.
D) unknown based upon the information provided.
Answer: B
Status: Old
8) Assume a consumer has a horizontal demand curve for a product. His consumer surplus from buying
the product
A) is maximized.
B) can't be calculated.
C) equals zero.
D) Need more information.
Answer: C
Status: Old
3
9) The above figure shows the market demand curve for telecommunication while driving one's car (time
spent on the car phone). The current price is 35¢ per minute. If the price were to increase by ten cents per
minute, consumer surplus would
A) fall to $820.
B) fall by $84.
C) fall by $58.
D) fall to $369.
Answer: B
Status: Old
10) The above figure shows the market demand curve for telecommunication while driving one's car
(time spent on the car phone). The current price is 35¢ per minute. What is the consumer surplus at the
current price?
A) 924.5
B) 1075
C) 301
D) 1250
Answer: A
Topic: Willingness to Pay
Status: New
4
11) Sandy's uncompensated demand for candy is given by the equation Q = 15/p, where Q is the quantity
of candy and p is the price. When the price of candy rises from $1 to $3, the change in consumer surplus
is
A) $16.5.
B) -$20.
C) -$15.
D) $15.
Answer: A
Status: Old
12) Sandy's current consumer surplus for candy is 20. Candy is a normal good for her. When her income
increases and the price of candy remains unchanged, her consumer surplus will
A) increase.
B) decrease.
C) remain the same.
D) Not enough information.
Answer: A
Status: New
13) Sandy's current consumer surplus for candy is 20. Candy is an inferior good for her. When her income
increases and the price of candy remains unchanged, her consumer surplus will
A) increase.
B) decrease.
C) remain the same.
Answer: B
Status: New
For the following, please answer "True" or "False" and explain why.
14) Consumer surplus from a given purchase is the difference between what one was willing to pay for
that purchase and what was actually paid.
Answer: True. This is the definition of consumer surplus.
Status: Old
5
15) The above figure shows an individual's demand curve for time per month spent telecommunicating
while driving (talking on the car phone.) A car phone is useless except for talking with somebody who is
not in the car. If calls are priced at ten cents per minute, what is the consumer surplus derived from
talking? What is the most this person would pay for the car phone? Explain.
Answer: The consumer surplus from talking on the car phone is ($2.90 ∗ 20)/2 = $29. This person would
pay up to $29 per month to have the phone. Having the phone is worth $29 per month to this person
because that is the value this person places on calls from the car phone over and above what is paid just
for the calls. The phone has no other value to the person except to make the calls. If the phone cost more
than $29 per month this person would feel better off without the phone.
Status: Old
16) Ted's uncompensated demand function for bacon is given by Q = 15/p. What is Ted's change in
consumer surplus when the price of bacon rises from p = 3 to p = 5?
Answer: Integrate the area under the uncompensated demand:
= 15ln(p)
Evaluate between p = 3 and p = 5:
15ln(5) - 15ln(3) = 7.66
Status: Old
6
17) Ralf's uncompensated demand function for shoes is given by Q = 100/p. What is the change in
consumer surplus when the price of shoes rises from p=20 to p=25?
Answer: Integrate the area under the uncompensated demand:
= 100 ln(p)
Evaluate between p = 20 and p = 25:

100 ln(25) - 100 ln(20) = 22.31
Status: Old
5.2 Expenditure Function and Consumer Welfare
1) The Equivalent Variation for an increase in the price of a good is

A) the reduction in a consumer's income necessary to harm the consumer by as much as the price
increase.
B) the increase in a consumer's income necessary to eliminate the consumer's harm from a price increase.
C) the change in consumer surplus resulting from a price increase.
D) the amount of money a consumer would accept to be subject to a price increase.
Answer: A
Topic: Expenditure Function and Consumer Welfare
Status: Old
2) The Compensating Variation for an increase in the price of a good is

A) the minimum amount of money a consumer would accept to voluntarily accept the price increase.
B) the maximum amount of money a consumer would pay to avoid the price increase.
C) the change in consumer surplus resulting from a price increase.
D) the change in utility resulting from the increase in price.
Answer: A
Status: Old
3) 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
Status: Old
7
4) The compensation variation and equivalent variation will be closer to each other when
A) the income elasticity is greater.
B) the budget share is greater.
C) the price change is smaller.
D) the income elasticity is smaller.
Answer: D
Topic: Comparing the Three Welfare Measures
Status: New
5) Suppose an analyst attempts to estimate a consumer's willingness to pay for a policy that lowers the
price of childcare. The willingness to pay should be measured as
A) BCafter to BCA.
B) BCafter to BCB.
C) BCafter to BCbefore.
D) BCA to BCB.
Answer: B
Topic: Indifference Curve Analysis
Status: New
6) The equivalent variation is always less than the consumer's income
Answer: True. The amount a person will pay to prevent a price change (EV) cannot exceed their available
income.
Status: Old
8
7) The difference between the equivalent variation and compensating variation is greater for goods with
large income elasticities.
Answer: True. According to the Slutsky equation, the difference between the compensated demand and
uncompensated demand elasticity is given by the product of budget share and income elasticity. For
larger income elasticities, the difference between these measures will also be larger.
Status: Old
8) Ed's utility from vacations (V) and meals (M) is given by the function U(V,M) = V2M. Last year, the
price of vacations was $200 and the price of meals was $50. This year, the price of meals rose to $75, the
price of vacations remained the same. Both years, Ed had an income of $1500.
a. Calculate the change in consumer surplus from meals resulting from the change in meal prices.
b. What is the compensating variation for the price change in meals?
c. Calculate the equivalent variation for the price change in meals.
Answer:
a. Ed's optimization problem is
Max V2M
Subject to pMM + 200V = 1500
where pM is the price of meals. Using the Lagrangian, we derive the demand for meals:
M* = 500/pM
The change in consumer surplus is found from the integral:
∆CS = ∫50 75 500/pMdpM = -500 ln(pM)| 50 75 = -500 [ln(75) – ln(50)] = –202.7
So the change in consumer surplus is –$202.7.
b. The CV is the amount of money needed to offset a consumer's harm from a price increase. Ed's utility
before the price change is based on his optimal consumption bundle.
M1 = 500/50 = 10
and V1 = 1000/200 = 5. His utility is U(5,10) = 5210 = 250. Now we look at the expenditure function when
pM = 75. The Lagrangian is:
L = 75M + 200V + [250 – V2M]
The optimization conditions are:
LM = 75 – V2 = 0
LV = 200 – 2MV = 0
L = 250 – V2M = 0
The first two conditions yield
3/4 = V/M
So V = 3M/4. Plug into the utility function
250 = (3M/4)2M
Solving for M = 7.63. Solve for V = 5.72. The expenditure required to purchase this bundle is:
75M + 200V = 75(7.63) + 200 (5.72) = 1717.25
Thus the CV is $1,500 - $1,717.25 = $217.25.
9
c. The EV is the amount of money Ed will pay to prevent the price increase. To find this, we start by
finding his utility after the price change with an income of $1500. From above, V = 5 and M = 500/75 =
6.67. His utility from this bundle is U = (5)2(6.67) = 166.75. The Lagrangian to find the expenditure
function is:
L = 50M + 200V + [166.75 – V2M]
The optimization conditions are:
LM = 50 – V2 = 0
LV = 200 – 2MV = 0
L = 166.75 – V2M = 0
Solve for the optimal bundle:
M = 8.74, V = 4.37.
The expenditure is:
50(8.74) + 200(4.37) = 1311.
Ed would pay up to 1500 - 1311 = $189 to avoid the price change. This is the EV.
Status: Old
9) Jeremy derives all of his utility from consuming milk shakes; he devotes his entire $20 allowance to
milk shakes each week. Suppose the price of milk shakes rise from $2 to $4. Compute Jeremy's
Compensating Variation and Equivalent Variation.
Answer: The CV is the amount of money needed to return Jeremy to his original level of utility. He
initially consumes 20/2 = 10 shakes per week. The only way to make Jeremy as happy as before after the
price rises is to give him enough income so that he can still consume 10 shakes. Thus we would need to
increase his income from $20 to $40. CV = -$20.
The EV is the amount Jeremy would pay to prevent the price increase. To compute this, notice that
Jeremy consumes just 20/4 = 5 shakes after the price increase. He would be willing to pay $10 of his
income to prevent the price change leaving him to consume 10 shakes. Thus the EV=-$10
Status: Old
10
10) Ian views playing Wartcraft and drinking soda as perfect complements (one soda with one hour of
playing Wartcraft). Currently, sodas are $1 each and Wartcraft costs $1 per hour. Ian has $12 of income.
a. Compute Ian's Compensating Variation if the price of Wartcraft rises to $2.
b. Compute Ian's Equivalent Variation if the price of Wartcraft rises to $2.
c. Compute Ian's change in Consumer Surplus if the price of Wartcraft rises to $2.
Answer:
a. Ian initially will purchase six units of each. When the price of Wartcraft rises to $2, the only bundle
which will return Ian to the same indifference curve is (6,6). This bundle now costs $18. Thus the
CV = $12 - $18 = -$6. We need to pay Ian $6 to return him to the initial utility level following the price
change.
b. After the price change, with an income of $12, Ian will purchase 4 units of each good. If the prices
were still $1 each, then the income level that puts Ian at the bundle (4,4) is $8. So the EV = $8 - $12 = -$4.
c. Denote W and S as the quantities of each good. Perfect complements implies that W=S in the
optimum. The budget constraint implies that pW + S = 12, where p is the price of Wartcraft and the price
of soda is 1. Solve for W=12/(1 + p). The CS is the integral of 12/(1 + p) between p = 1 and p = 2. This solves
to be $4.87 (approx.).
Status: Old
11) Suppose you work for a government agency that is considering removing certain agricultural
subsidies. The removal of these subsidies will increase the price, thus lowering consumers' welfare.
Because only aggregate market data is available, you are unable to measure the exact values for the
compensated and equivalent variation by consumer. However, you are able to estimate the change in
market consumer surplus. Assuming agricultural products are normal goods, how does your estimate of
consumer surplus compare to the unknown EV and CV? Explain. Under what conditions will the three
measures of welfare be close to one another?
Answer: For normal goods, the CS will be less than the CV and greater than the EV (in absolute value).
Typically, these measures will be close for (1) small price changes, (2) small income effects/elasticity, and
(3) small budget share.
Status: Old
12) Kisa consumes the same amount of cigarettes each week regardless of her income (assume that her
income is sufficiently large such that the quantity is affordable). The Equivalent Variation equals the
Compensating Variation.
Answer: True. The difference between the measures lies with the income effect/elasticity. There is no
income effect for Kisa therefore the measures will be the same.
Status: Old
11
13) Suppose an analyst attempts to estimate a consumer's willingness to pay for a policy that lowers the
price of childcare by measuring the amount of income that can be taken away from the consumer (at the
new price) such that they can just afford their original bundle of goods. Is this correct? If not, is it more or
less than the true compensating variation? Explain with a graph.
Answer:
It is less than the true compensating variation. The drop in income from the BC after to BCB is the CV. The
drop from BCafter to BCA is the amount of income that can be taken away leaving the original bundle
just affordable.
Status: Old
12
14) A study of the benefits of television asked consumers two questions: (1) How much would you pay to
watch TV (versus no TV watching), and (2) How much would you have to be paid to voluntarily stop
watching TV. Show how these are found with two separate graphs of indifference curves and budget
constraints. Are these values likely to be equal? Discuss briefly.
Answer: The first question is the willingness to pay for TV (all or nothing).
Original bundle = a
Without TV = b
With TV but income reduced = d.
The CV is the amount of income we can take away that keeps the consumer on the same IC as when TV is
banned.
13
The second question asks for the willingness to accept:
Original bundle = a
Without TV= b
Without TV but compensated = c
CV is the amount needed to compensate her for the loss is the amount of income needed to shift BC to
BC'.
These are different questions and represent different changes in income. A person typically will pay less
than they will accept due to the income effect from having the initial right (the right to watch TV, for
example).
Status: Old
14
15) A consumer has the quasi-linear utility function
U(q1,q2) = 64q11/2 + q2
Assume p2 = 1 and Y = 100. Find the consumer's compensating and equivalent variations for an increase
in p1 from 1 to 2.
Answer: First, find her demand for good 1:
q1 = 16/p12
It is helpful to write her utility in terms of q1 and her expenditures/income:
= 64q11/2 + E - p1q1
When p1=1, her demand is q1=16. Her utility is then:
= 64(16)1/2 + 100 - 16 = 596
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:
596 = 64(4)1/2 + 100 + CV - 4
Thus, CV = 372.
The EV is found by the equation
64(16)1/2 + 100 - EV - 16 = 64(4)1/2 + 100 - 4
Notice this is the same as the equation above so EV = CV.
Status: Old
5.3 Market Consumer Surplus
1) As the price of a good increases, the loss in consumer surplus is larger,

A) the more elastic demand is.
B) the more money previously spent on the good.
C) the less money previously spent on the good.
D) the smaller the price increase.
Answer: B
Topic: Market Consumer Surplus
Status: Old
2) Sarah's demand curve for whiskey has the same slope as Pete's; however, it lies to the right of Pete's.
An increase in the price of whiskey will cause
A) Sarah to incur a greater loss of consumer surplus than Pete will.
B) Pete to incur a greater loss of consumer surplus than Sarah will.
C) Sarah and Pete to incur the same loss of consumer surplus.
D) Sarah's demand curve to shift closer to Pete's.
Answer: A
Status: Old
15
3) 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
Status: Old
4) Sarah and David both have linear demand curves for lemonade. Sarah's demand is more elastic than
David's. At the current price of $0.50 per glass, they both choose to buy 5 glasses. A change in the price of
lemonade to $0.75 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: B
Topic: Markets in Which Consumer Surplus Losses Are Large
Status: New
16
5) The above figure shows the market demand curve for telecommunication while driving one's car (time
spent on the car phone). At the current price of 35¢ per minute, consumer surplus equals
A) $301.
B) $924.50.
C) $1,225.50.
D) $1,250.
Answer: B
Status: Old
6) If lower-income households spend a greater share of their income on cigarettes than do higher-income
households, then a tax that raises the price of cigarettes will
A) cause lower-income households to incur a greater loss of consumer surplus than that incurred by
higher-income households.
B) cause higher-income households to incur a greater loss of consumer surplus than that incurred by
lower-income households.
C) raise consumer surplus among higher-income households.
D) cause consumer surplus to decline among smokers, but the relative impact cannot be determined from
the given information.
Answer: D
Status: Old
17
7) Suppose consumers of cigarettes can be classified into two groups: heavy users and light users. Heavy
users purchase more cigarettes and are less sensitive to price changes relative to light users. To determine
whether a heavy user suffers a greater loss of consumer surplus than a light user does when the price of
cigarettes increases, one would need to know
A) each group's average income.
B) the actual quantities purchased by each.
C) each individual's price elasticity of demand.
D) no additional information.
Answer: D
Status: Old
8) Consumers who are more sensitive to changes in price suffer a greater loss of consumer surplus from
any given price increase.
Answer: False. Consumers who are more sensitive to the price increase will reduce their purchase of the
good by a greater extent than those who are not price sensitive. As a result, they incur a smaller loss of
consumer surplus.
Status: Old
9) The change in total welfare from a 10% increase in price will depend only on the elasticity of demand.
Answer: False. The effect of a price change also depends on revenue changes.
Status: Old
18
10) Ann and Bill each spend $30 per month on cigarettes when the price is $1 per pack. Draw a graph to
illustrate that the consumer with the less elastic demand will suffer the greater loss of consumer surplus
when the price of cigarettes increases. Explain and label the figure.
Answer:
See the above figure. The curve labeled LE is the less elastic demand curve, and the curve labeled ME is
the more elastic demand curve. When price increases from $1 to pn, the person with demand curve ME
suffers a loss of a + c + e. The person with demand curve LE suffers a loss of a + b + c + d + e. Thus the
person with the less elastic demand suffers the greater loss of consumer surplus.
Status: Old
5.4 Effects of Government Policies on Consumer Welfare
1) A quota will reduce consumer welfare when

A) the quota is less than the amount purchased without the quota.
B) the quota is greater than the amount purchased without the quota.
C) the quota is on a good with high income elasticity.
D) Quotas always reduce consumer welfare.
Answer: A
Topic: Effects of Government Policies on Consumer Welfare
Status: Old
19
2) 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
Status: Old
3) Julia is offered two options of government subsidies: $100 food stamp or $100 cash. If she receives $100
cash, she will spend $80 on food. If equivalent evaluation is measured for the situation when only $100 is
available to her, the equivalent evaluation is
A) greater than $100.
B) equal to $100.
C) less than $100.
Answer: C
Topic: Food Stamps
Status: New
4) Suppose a consumer purchases Food (F) and other goods (X) with their income of $100. For simplicity,
suppose that food and other goods are measured in $1 units, so the price of each is $1. Currently, the
consumer can purchase unlimited food stamps by paying 10¢ for $1 of food. With this, the consumer
purchases 500 food stamps (for 500 units of food) and 50 units of X. As a result, the government must pay
90¢ towards food, for a total cost of $450. Using a graph of budget constraints and indifference curves,
show that the consumer prefers to receive a cash gift of $450 over the food stamp option.
Answer:
Without food stamps, the budget constraint is BC0. Food stamps enable the consumer to effectively
purchase food for $.10 (rather than $1), resulting in BC 1 and an optimal bundle at the tangency with IC1.
Alternatively, if the government eliminates food stamps but provides $450, the budget constraint is
parallel to BC0. The consumer is still able to purchase the same bundle under the food stamp policy, but
now can reoptimize to reach the higher indifference curve.
Status: Old
20
5) During droughts, cities often impose water use restrictions on consumers. Suppose a representative
consumer has preferences for Water (W) and other goods (X) given by the utility function:
U(W,X) = WX.
Suppose the price of other goods is $1 and the price of water is initially 50¢. The consumer has a budget
of $50/week.
a. How much water will the consumer purchase each week?
b. Suppose the government imposes a quota on water use of 50 units/week. Show that the quota
reduces the representative consumer's utility.
c. By how much does the quota harm the representative consumer? Specifically, compute the equivalent
variation of the quota.
Answer:
a. The consumer will choose 100 units of water per week.
b. Since the consumer can no longer consumer the optimal bundle from before, she will choose a bundle
of 50 units of water (costing $25) and spend $75 on other goods. Her utility before was U(100,50)=5000
and now is U(50,75) = 3750. She is indeed worse off from the quota.
c. We wish to find the amount of income which will lead to a utility of 3750 without a quota. The MRS =
MRT condition is X/W = .5/1, or 2X = W. Plugging into the utility function, 2X 2 = 3750 or X = 43.3. So Y =
86.6. The Expenditure for this bundle of goods is $86.6. Thus the EV is 86.6 - 100 = -13.4.
Status: Old
21
6) Rachel has an income of $10 which she spends on burritos and other goods ("other goods" represents a
composite of all other goods). The price of burritos is $1 as is the price of other goods.
a. Suppose the government agrees to pay half of Rachel's burrito bill, so burritos now cost her $.50
apiece. She now chooses to buy eight burritos. On a graph with Burritos on the x-axis and other goods on
the y-axis, draw Rachel's budget constraints before and after the subsidy program. Also include an
indifference curve and the coordinates of Rachel's optimal bundle with the subsidy.
b. Now, suppose the government ends the program in part a. and replaces it with a new and simpler
program: Rachel just gets a cash gift of $4. Show his new budget line. Is Rachel still able to afford her
optimal bundle that she chose with the subsidy?
c. How much does each program cost the government? Which program does Rachel prefer? Explain.
Answer:
a.
b. It goes through the point (6,8) so it is just affordable with the new policy.
c. They both cost the same. Before, Rachel was purchasing 4 burritos, so it cost $4 to the government.
Now, the government is paying $4 total.
Rachel is better because she can now reach a higher indifference curve.

Status: Old
22
7) Steve's utility for socks (q1) and other goods (q2) is given by
U(q1,q2) = 10q1.1 q2.9
The price of the composite good is p2=1 and the price of a pair of socks is p1=2. Steve's income is Y=100.
Every year, Steve's mom buys him 20 pairs of socks. Find the equivalent variation of the gift. What is the
difference between the cost of the gift and the equivalent valuation cash amount?
Answer: First determine the utility level from the gift. At the bundle (20,100), MRS = .55, whereas
MRT = 2, implying a corner solution with the gift: Steve consumes (12,100) and U(12,100) = 809. To find
cash equivalent (EV), first set MRS = MRT: q 2 = 18q1. Plug into utility function and solve:
809 = 10q1.1(18q1).9
Solve to get q1 = 6 and q2 = 108. The cost of this bundle is 120, so the EV = 20. The gift cost $40 whereas
Steve would be just as happy with $20 in cash.
Status: Old
23
8) A consumer has $100 of income to spend on books and other goods (a composite good). Books cost $20
each and the consumer's optimal bundle is to consume purchase three books while spending the rest of
the income on the composite good. The consumer is then given a gift of a book. Assume the consumer is
unable to sell the book. Use two separate graphs to demonstrate each of the two possible scenarios:
i. A consumer that is indifferent between the book gift and a cash gift of $20.
ii. A consumer that strictly prefers a $20 cash gift to a book.
To get full credit, accompany each graph with a brief explanation and draw your graphs clearly and well
labeled.
Answer:

Status: Old
24
9) Job is a smoker. He has a utility function for cigarettes smoked in bars (q 1) and a composite good (q2)
given by
U(q1,q2) = 10q1.5 + q2
Job's income is $100 and faces prices p1 = 5 and p2 = 1. The government is planning to ban smoking in
bars. Compute the compensating variation.
Answer: Find the utility before the smoking ban. Set MRS = MRT (or use Lagrangian method) to
compute the optimal bundle. Solving yields q1=1 and q2 = 95. The utility = 105. To reach the same utility
when q1 = 0, the consumer would need an additional $5 of income, i.e. CV = 5.
Status: Old
5.5 Deriving Labor Supply Curves
1) The price of leisure

A) is the same for everyone.
B) depends on the number of hours worked.
C) is measured as foregone earnings.
D) is immeasurable.
Answer: C
Topic: Deriving Labor Supply Curves
Status: Old
2) 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
Status: Old
3) If a person supplies fewer 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: B
Status: Old
25
4) Empirical studies have found that the labor supply curves for most parts of the population are
A) backward-bending.
B) upward sloping.
C) downward-sloping.
D) nearly vertical.
Answer: D
Status: Old
5) A backward-bending labor supply curve implies that

A) the substitution effect dominates the income effect at higher wage rates but not at lower wage rates.
B) the substitution effect dominates the income effect at lower wage rates but not at higher wage rates.
C) leisure is an inferior good.
D) workers are irrational.
Answer: B
Status: Old
6) A backward-bending labor supply curve could possibly imply which of the following cases?
A) Leisure is an inferior good.
B) Leisure is a normal good.
C) Leisure is a normal good at low wages and inferior at high wages.
D) None of the above.
Answer: B
Topic: Shape of the Labor Supply Curve
Status: New
7) 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
Status: Old
8) A tax cut that raises the after-tax wage rate will most likely result in more hours worked if
A) tax rates were low already.
B) the relevant portion of the labor supply curve is upward sloping.
C) the relevant portion of the labor supply curve is downward sloping.
D) workers can be easily fooled.
Answer: B
Status: Old
26
9) If workers are in the backward-bending section of their labor supply curves, than an increase in the
income tax rate will
A) increase the tax revenue and increase the number of hours worked.
B) increase the tax revenue and decrease the number of hours worked.
C) decrease the tax revenue and increase the number of hours worked.
D) decrease the tax revenue and decrease the number of hours worked.
Answer: A
Status: Old
10) 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.
D) have a backward bend in her labor supply curve.
Answer: B
Status: Old
11) In response to an increase in the wage rate, the income effect will usually cause a person to
A) supply fewer hours of labor.
B) supply more hours of labor.
C) supply the same hours of labor.
D) have a horizontal labor supply curve.
Answer: A
Status: Old
27
12) The graph below shows George's indifference curves and budget lines. From A to B, we can
conclude
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
Status: New
13) 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
Topic: Income Tax Rate and the Labor Supply Curve
Status: New
28
14) A tax cut will unambiguously lower income-tax revenue.
Answer: False. It depends on how the quantity of labor supplied responds to the increase in the after-tax
wage rate. If the income effect dominates, the quantity of labor supplied falls and so will tax revenue. If
the substitution effect dominates, the quantity of labor supplied increases, and income-tax revenue could
increase. This is a function of whether the after-tax wage was low already because the tax rate was
relatively high.
Status: Old
15) An increase in unearned income always creates a disincentive to work

Answer: False. The effect on labor supply will also depend on the individual's preferences towards work
(leisure).
Status: Old
16) The above figure shows an indifference map for a person's choices between leisure and consumption.
Derive this person's labor supply curve for wage rates of $5, $10, and $15.
Answer: This person's labor supply curve is downward sloping. The three coordinates for w,H are
approximately (5,14), (10,11), and (15,9).
Status: Old
29
17) Draw a graph with Goods Per Day on the vertical axis and Leisure Hours Per Day increasing from left
to right on the horizontal axis. Show that a person who works can work fewer hours and increase utility
when the wage rate increases.
Answer:
See the above figure.

Status: Old
18) Suppose a person's utility for leisure (L) and consumption (Y) can be expressed as U = Y + L0.5. Show
what happens to the person's labor supply curve when the income tax is cut from 70 % to 30 %. Denote
hours worked as H and wage per hour as w.
Answer: Since Y = net income, U = w(1 - t)H + (24 – H)0.5. Maximizing utility with respect to hours
worked, H, yields H = 24 - (2(1 - t)w)-2. Any decrease in t would increase the number of hours worked.
Note: This person is a workaholic. Even at a net wage of $1, this person only relaxes for 3/4 of an hour!
Status: Old
19) Suppose a person's utility for leisure (L) and consumption (Y) can be expressed as U = Y + L0.5.
Assuming a wage rate of $10 per hour, show what happens to the person's labor supply curve when the
person wins a lottery prize of $100 per day.
Answer: Rearranging yields U = (Y* + 10H) + (24 – H)0.5. Maximizing utility with respect to H yields
H = 23.9975 hours. Note: H is not a function of Y * because the marginal utility of leisure is independent of
income. Thus the person's labor supply curve is not affected by winning the lottery.
Status: Old
30
20) Suppose a person's utility for leisure (L) and consumption (Y) can be expressed as U = Y ∗ L 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 – 10H2. Maximizing utility
with respect to H yields dU/dH = 240 - Y* - 20H = 0. 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.
Status: Old
31
21) Consider a consumer with preferences for consumption of a composite good (C) and leisure (L) given
by the following utility function:
U(C,L) = 2C1/2 + L
Denote the consumer's wage rate by w and total time available for labor and leisure is normalized to one.
The price of consumption is one. Denote the amount of labor supplied as N, so that N+L= 1. The
consumer also earns non-labor income ("allowance") of 0.
a. Write out the budget constraint determining feasible allocations of leisure and consumption.
b. Compute the optimal bundle of leisure and optimal bundle of consumption.
c. Derive the consumer's labor supply function: N*(w, ).
d. Determine the effect of increasing non-labor income on the supply of labor (that is, compute the
relevant partial derivative).
e. How does non-labor income affect the consumption of the composite good, C?
f. Compute the effects of an increase in wage on consumption and labor supply. Is leisure a normal
good?
Answer:
a. π + w = C + wL
In words, the amount of consumption goods (in $) equals the allowance plus earnings from work. The
reformulation is just rearrangement to look more like our "typical" BC where income (maximum earnings
from work plus allowance) equals the consumption of goods plus the consumption of leisure (where w is
the "implicit price" of leisure).
b. Optimization using a Lagrangian:
L = 2C1/2 + L + [ π + (1– L)w – C]
The derivatives are
LC = C-1/2 – π = 0
LL = 1 – w = 0
L = π + (1– L)w – C = 0
The first two conditions imply
C* = w2
Substitute in to the third condition to get
L* = 1 + /w – w
Notice that L < 1 requires:
π < w2.
Alternatively, the optimal bundle is L* = 0 and C* = w + π (a corner solution).
c. N* = 1 – L* = w – π /w
d. dN/dπ = -1/w < 0
e. It doesn't.
f. dN/dw = 1 + π/w2 > 0; dC/dπ = 2w > 0. Neither of these derivatives tells us whether leisure is normal.
To find out if leisure is normal, we simply need to isolate the income effect. This is seen by looking at the
effect of non-labor income on leisure, which is positive. Leisure is therefore normal.
Status: Old
32
22) What does it mean to say the labor supply is backwards bending? How does this relate to the direction
and magnitude of the income and substitution effects? Will the labor supply be backwards bending if
Leisure is a normal good? Will it be backwards bending if Leisure is an Inferior good?
Answer: Backwards bending means that as the wage rate increases, the amount of labor supplied may
increase, but then decrease as the wage rises high enough. When leisure is a normal good, the income
effect and substitution effect of a wage increase move in opposite directions. When the income effect
dominates the substitution effect, the labor supply is backwards bending. If leisure is an inferior good, the
two effects move together and the labor supply does not bend backwards.
Status: Old
33

Microeconomics Theory and Applications With Calculus 3rd Edition Perloff Test Bank 1

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Microeconomics Theory and Applications With Calculus 3rd Edition Perloff Test Bank 1

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Test Bank for Microeconomics Theory and

Applications with Calculus 3rd Edition Perloff

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Microeconomics: Theory and Applications with Calculus, 3e (Perloff)

5.1 Consumer Welfare

Evaluate between p = 20 and p = 25:

5.2 Expenditure Function and Consumer Welfare

1) The Equivalent Variation for an increase in the price of a good is

2) The Compensating Variation for an increase in the price of a good is

5.3 Market Consumer Surplus

1) As the price of a good increases, the loss in consumer surplus is larger,

5.4 Effects of Government Policies on Consumer Welfare

1) A quota will reduce consumer welfare when

Topic: Effects of Government Policies on Consumer Welfare

Topic: Effects of Government Policies on Consumer Welfare

5.5 Deriving Labor Supply Curves

1) The price of leisure

2) If a person supplies more hours of labor in response to a wage increase, then

3) If a person supplies fewer hours of labor in response to a wage increase, then

5) A backward-bending labor supply curve implies that

A) leisure is a normal good.

15) An increase in unearned income always creates a disincentive to work

See the above figure.

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