Deck 10: Consumer Surplus and Deadweight Loss

Question 1

Whenever indifference curves have kinks,marginal willingness to pay curves have horizontal "flat spots".

Answer 1

False
If anything,they will have vertical "flat spots" as the MRS (a variant of which appears on the vertical axis of marginal willingness to pay curves)is not well defined at the kink quantity but is defined everywhere else.

Question 2

Consumer surplus is accurately measured along (uncompensated)demand curves when tastes are quasilinear.

Answer 2

True
When tastes are quasilinear,compensated and uncompensated demand curves lie on top of one another -- so the uncompensated demand curve can be treated as if it were a MWTP curve.

Question 3

For perfect complements,the (uncompensated)demand curve slopes down and the compensated demand (or MWTP)curve is perfectly vertical.

Answer 3

True
There are no substitution effects --- which implies compensated demand curves (that only incorporate substitution effects)must be vertical.Perfect complements are also normal goods (at least in the 2-good model)-- thus the uncompensated demand curve slopes down.

Question 4

The following graph applies to a consumer for whom good x is an inferior good.The price of x falls from p to p',and one of the curves below represents the consumer's (uncompensated)demand curve while the other represents the consumer's compensated demand (or MWTP)curve.
a.Which curve is which? (Explain.)
b.What is it about these curves that makes them intersect at the original price p?
c.Once the consumer has optimized at the new price p',illustrate the new (uncompensated)demand and the new MWTP curve.
d.For curves that have shifted,explain why; for curves that have not shifted,explain why as well.

Question 5

If tastes are homothetic,there exists a utility function that represents those tastes and that gives rise to an expenditure function which is homogeneous of degree 1 in utility.

Question 6

Price subsidies have no deadweight losses so long as the (uncompensated)demand curve is vertical.

Question 7

As we move to higher indifference curves,compensated demand (or MWTP)curves shift to the right.

Question 8

An increase in income causes compensated demand curves to shift inward and regular demand curves to shift outward.

Question 9

Indirect utility functions are homogeneous of degree 1 in income.

Question 10

Why is the following statement incorrect: "A tax on all consumption goods is efficient because it equally taxes all goods and therefore does not distort their prices."

Question 11

When tastes are not quasilinear,the positive economist will introduce error into the analysis if he uses the uncompensated (rather than the compensated)demand curve to analyze changes in consumer surplus.

Question 12

Suppose Coke and Pepsi are perfect substitutes.
a.Derive the shape of the (uncompensated)demand curve.
b.Derive the shape of the compensated demand (or MWTP)curve.

Question 13

When a taxed good is normal,using the (uncompensated)demand curve to estimate deadweight loss will over-state the actual deadweight loss.

Question 14

Explain the following statement: "People hate taxes primarily because of income effects while economists hate taxes primarily because of substitution effects."

Question 15

Consider a worker who consumes a composite consumption good (on the vertical axis)and leisure hours (on the horizontal axis).
a.Suppose the worker has 80 hours of leisure per week and can earn a wage of $50 per hour.Illustrate the worker's weekly budget constraint.
b.In order to close the deficit,the government introduces a broad-based consumption tax on all consumer goods -- raising the price of the consumption good by 20%.Illustrate the new budget constraint faced by our worker.
c.On your graph,indicate the level of tax revenue raised by this broad-based consumption tax.
d.Using your graph,discuss why this tax is inefficient.
e.In this model is there any difference between the consumption tax and a wage tax? What is different about the real world that would change your conclusion about this?

Question 16

There is a compensated demand (or MWTP)curve for every indifference curve just as there is an uncompensated demand curve for every income level.

Question 17

Suppose x is an inferior good.Then we will overestimate the deadweight loss from taxes on consumption good x if we use the uncompensated demand curve rather than the marginal willingness to pay (or compensated demand)curve.

Question 18

When tastes are not quasilinear,the positive economist will introduce error into the analysis if he uses the uncompensated (rather than the compensated)demand curve to predict behavior.

Question 19

If tastes are homothetic,there exists a utility function (that represents those tastes)such that the indirect utility function is homogeneous of degree 1 in income.

Question 20

If a person's compensated demand (or MWTP)curve is perfectly vertical,the good is borderline between regular inferior and Giffen for this consumer.