Deck 5: Using Consumer Choice Theory

Question 1

Which of the following is true of an excise subsidy?

A)An excise subsidy has a positive substitution effect but negative income effect on the consumption of the subsidized good.
B)An excise subsidy increases consumption of the subsidized good more than a cash transfer of equal-cost.
C)An excise subsidy leaves the well-being of the subsidy recipient unchanged.
D)An excise subsidy causes consumption of nonsubsidized goods to increase.

Answer 1

An excise subsidy increases consumption of the subsidized good more than a cash transfer of equal-cost.

Question 2

An excise subsidy given on clothing will encourage consumers to purchase:

A)more clothing due to the substitution effect.
B)less clothing due to the income effect.
C)more clothing and less of other goods.
D)less clothing since clothing is an inferior good.

Answer 2

more clothing due to the substitution effect.

Question 3

Which of the following is a consequence of subsidizing consumers using a per-unit excise subsidy for the purchase of some good or service as opposed to a lump-sum payment of an equal amount?

A)Consumers will not necessarily be better off according to their own preferences.
B)The deadweight loss from over-consumption of the good or service is avoided.
C)Consumers will move to a higher indifference curve.
D)Consumers' purchase decisions will be based on their true valuation of the good.

Answer 3

Consumers will not necessarily be better off according to their own preferences.

Question 4

An excise subsidy given on each unit of X consumed will:

A)reduce consumption of X and lower total expenditures on X.
B)shift the budget line inward in a parallel manner.
C)place the consumer on a higher indifference curve.
D)cause the consumer to increase consumption of non-subsidized goods.

Question 5

The U.S.government in effect subsidizes health care of workers by:

A)relaxing health care regulations.
B)having lower tax rates on wages and salaries.
C)not taxing health care benefits.
D)reducing taxes on firms and small businesses.

Question 6

Figure 5-1 shows the preferences of a consumer for food and other goods.He is initially in equilibrium at point A where the budget line MN is tangent to the indifference curve.
In Figure 5-1,the total cost incurred by the government on the lump-sum transfer is given by _____.

A)CE'
B)BF
C)CH
D)BJ

Question 7

In an attempt to encourage the use of solar energy,the government pays a part of the price of solar panels to the producer and allows consumers to buy as many panels as they wish at the subsidized price.This is an example of a(n)_____.

A)excise subsidy
B)fixed-quantity subsidy
C)voucher program
D)lump-sum transfer

Question 8

Use the following figure to answer the question: Figure 5-2 :shows the quantity demanded of a good at various prices.
Refer to Figure 5-2.The deadweight loss of an excise subsidy that lowers the price from P₁ to P₂ is area _____.

A)P₁ACP₂
B)P₁BCP₂
C)ADC
D)ABC

Question 9

Figure 5-1 shows the preferences of a consumer for food and other goods.He is initially in equilibrium at point A where the budget line MN is tangent to the indifference curve.
In Figure 5-1,the total outlay on food before the excise subsidy is given by _____.

A)KC
B)0G
C)0H
D)0J

Question 10

The welfare effect of an excise subsidy indicates that:

A)the consumer is better off than without the subsidy.
B)the consumer is indifferent between an excise subsidy and a cash grant.
C)excise subsidies should not be used by the government.
D)government officials know what is better for low-income families than the families themselves.

Question 11

Use the following figure to answer the question: Figure 5-2 :shows the quantity demanded of a good at various prices.
Based on Figure 5-2,the welfare cost of an excise tax (that raises price from P₂ to P₁)is the area _____.

A)P₁ACP₂
B)P₁BCP₂
C)ADC
D)ABC

Question 12

Being a member of the government-sponsored MediSave scheme entitles employees to a lump-sum payment in cash towards medical expenses.This scheme would:

A)increase employment.
B)make workers better off.
C)not change workers' welfare.
D)cause average wages to fall.

Question 13

Comparing the original budget line with the budget line for an excise subsidy and a cash grant:

A)the budget line for a cash grant shifts such that it is tangent to the same indifference curve so that the well-being of the consumer is the same.
B)the slope of the budget line for a cash grant is positive.
C)the budget line for a cash grant is parallel to the original budget line.
D)the budget line for an excise subsidy shifts such that it is tangent to the same indifference curve so that the well-being of the consumer is the same.

Question 14

Which of the following is true of an excise subsidy?

A)An excise subsidy has both an income and a substitution effect which causes the consumption of the subsidized good to rise.
B)An excise subsidy has a substitution effect since the subsidy artificially lowers the price of the subsidized good causing the consumer to increase consumption of the good,but no income effect.
C)An excise subsidy increases consumption of a good by the same quantity as does a cash transfer but at a lower cost to the government.
D)An excise subsidy has an income effect since the subsidy increases the consumer's income but no substitution effect.

Question 15

Unlike an equivalent-sized cash transfer,an excise subsidy on good X:

A)has an income effect.
B)leaves the consumer better off.
C)has a substitution effect.
D)increases consumption of composite goods.

Question 16

Given a choice between an equal-cost cash grant and an excise subsidy,a consumer will:

A)prefer an excise subsidy.
B)prefer an excise subsidy if the good is a normal good.
C)be indifferent between an excise subsidy and a cash grant.
D)be worse off with an excise subsidy.

Question 17

Figure 5-1 shows the preferences of a consumer for food and other goods.He is initially in equilibrium at point A where the budget line MN is tangent to the indifference curve.
In Figure 5-1,the total outlay on other goods before the excise subsidy is given by _____.

A)0M
B)0N
C)0E
D)0G

Question 18

If an equal-cost lump-sum transfer were substituted for a per unit excise subsidy on good X:

A)the consumption of X under the excise subsidy would be higher and the consumer would be on a higher indifference curve.
B)the consumption of X under the excise subsidy would be higher,but the consumer would be on the same indifference curve.
C)the consumption of X under the lump-sum transfer would be higher and the consumer would be on a higher indifference curve.
D)the consumption of X under the lump-sum transfer could be higher,but the cost of the transfer would be higher.

Question 19

Compared to an equal-cost cash grant,an excise subsidy on clothing results in the purchase of:

A)more clothing and more of other goods.
B)less clothing and more of other goods.
C)more clothing and less of other goods.
D)less clothing and less of other goods.

Question 20

The effect of substituting an equal-cost lump-sum grant for an excise subsidy is to:

A)increase the consumption of the subsidized good and increase the consumption of other goods.
B)decrease the consumption of the subsidized good and increase the consumption of other goods.
C)decrease the consumption of the subsidized good and decrease the consumption of other goods.
D)increase the consumption of the subsidized good and decrease the consumption of other goods.

Question 21

Which of the following policies would work best towards reducing traffic jams?

A)Relaxation of government restrictions on the number of cars being produced and sold
B)A reduction in interest rates on car loans
C)The imposition of a marginal fee to use certain roads during peak traffic hours
D)A levy of a fixed annual payment by car owners as traffic congestion fees

Question 22

A subsidy can actually cause the consumption of subsidized goods to fall if:

A)the consumer has concave indifference curves.
B)the government prohibits resale of the good.
C)the price of other goods also falls.
D)the subsidized quantity of the good is fixed.

Question 23

Use the following figure to answer the questions : Figure : 5-5 shows a family's preferences toward schooling,before and after a fixed-quantity subsidy.

Prior to the subsidy,the family is in equilibrium at point J.Assume that public schooling cannot be supplemented with private tutoring.Refer to Figure 5-5.The fixed-quantity subsidy reduces schooling by _____.

A)G0
B)B0
C)BG
D)H0

Question 24

In which of the following cases can a subsidy possibly harm its recipients?

A)When consumption of the subsidized good is mandatory
B)When the subsidy is fully funded by the government
C)When the subsidy is targeted at low-income groups
D)When the good that is subsidized is a luxury good

Question 25

All-you-can-eat restaurants charge a fixed price that permits unlimited access to prepared food.Suppose food consumption is on the horizontal axis and all other goods on the vertical axis.If the restaurant charges $10 per meal while the price of all other goods is $20,restaurant patrons will consume to a point on their indifference curve where their marginal rate of substitution of food for all other goods is equal to _____.

A)2
B)1/2
C)10
D)0

Question 26

Compared to a system of providing education free of cost at government schools,a voucher program that provides the means for parents to send their school-age children to private schools at government expense:

A)will allow families to consume a higher quantity and better quality of education.
B)will lower the quality of education provided.
C)will not affect the quantity and quality of education.
D)will result in a lower quantity of education consumed.

Question 27

Suppose a local government decides to increase taxes on its residents and use that money to provide meals to each individual in the community.The scheme provides each individual with a small frozen dinner.Compared to a voucher system that allows individuals to purchase meals at a private restaurant,the frozen dinner scheme:

A)will decrease both quantity and quality of meals consumed.
B)will not affect the quality or quantity of meals.
C)will give individuals greater variety and choice of meals.
D)will increase both quantity and quality of meals consumed.

Question 28

Use the following figure to answer the questions : Figure : 5-5 shows a family's preferences toward schooling,before and after a fixed-quantity subsidy.

Prior to the subsidy,the family is in equilibrium at point J.Assume that public schooling cannot be supplemented with private tutoring.Refer to Figure 5-5.After the fixed-quantity subsidy has been introduced,the family consumes:

A)its optimum level of other goods.
B)less than its optimum quantity of schooling.
C)more than its optimum quantity of schooling.
D)less than its optimum quantity of other goods.

Question 29

Use the following figure to answer the questions : Figure : 5-5 shows a family's preferences toward schooling,before and after a fixed-quantity subsidy.

Prior to the subsidy,the family is in equilibrium at point J.Assume that public schooling cannot be supplemented with private tutoring.Refer to Figure 5-5.Public schooling provided in the amount of B0 causes the family to consume _____ of other goods.

A)MC
B)MH
C)M0
D)CH

Question 30

Use the following figure to answer the questions : Figure : 5-5 shows a family's preferences toward schooling,before and after a fixed-quantity subsidy.

Prior to the subsidy,the family is in equilibrium at point J.Assume that public schooling cannot be supplemented with private tutoring.Refer to Figure 5-5.Suppose the government offers education vouchers of value $B0 instead of a fixed-quantity subsidy.The budget line will become _____.

A)MATN
B)AS
C)MN
D)MAS

Question 31

Use the following figure to answer the questions : Figure : 5-5 shows a family's preferences toward schooling,before and after a fixed-quantity subsidy.

Prior to the subsidy,the family is in equilibrium at point J.Assume that public schooling cannot be supplemented with private tutoring.Refer to Figure 5-5.Public schooling provided in the amount of B0 causes the family to increase consumption of other goods by _____.

A)MC
B)MH
C)M0
D)CH

Question 32

Figure 5-4 shows a family's preferences for public and private healthcare.Refer to Figure 5-4.Suppose the government offers a fixed quantity subsidy of healthcare valued at $B0.The new budget line becomes _____.

A)MAS
B)MATN
C)MN
D)AS

Question 33

Which of the following groups are better off under an annual fee system of garbage disposal?

A)Households that generate the average amount of trash
B)Households that generate less than the average amount of trash
C)All households that opt for the annual fee system
D)Households that generate more than the average amount of trash

Question 34

One of the possible explanations for why more trash is generated in cities is that _____.

A)cities have a low population density.
B)trash collection services in cities are expensive.
C)trash disposal is an inferior good
D)most city dwellers do not have to pay per unit of trash generated

Question 35

Suppose the government provides $1,400 worth of educational services for all children.Assume that public schooling cannot be supplemented with private tutoring.What would be the cost of schooling for a family that desires educational services worth $1,700?

A)$0
B)$300
C)$1,700
D)Cannot be determined without more information

Question 36

Assume an indifference map with other goods on the vertical axis and health on the horizontal axis.The government provides families with $400 vouchers that can be redeemed for healthcare services at any hospital,public or private.The budget line for a family that avails this voucher scheme will:

A)be negatively sloped.
B)be positively sloped up to $400 and then have a zero slope.
C)have a zero slope up to $400 and then have a negative slope.
D)be a straight line with an infinite slope.

Question 37

Which of the following statements is true?

A)Consumers are better off with a fixed-quantity subsidy than an equal-cost voucher system.
B)Voucher systems will not increase the quantity consumed of the subsidized good.
C)With a fixed-quantity subsidy consumers will consume more of other goods.
D)Fixed-quantity subsidies and voucher systems can both place the consumer on a higher indifference curve.

Question 38

Figure 5-3 shows a family's preferences for housing and other goods.Refer to Figure 5-3.Suppose the government offered public housing that provided exactly B0 units of housing services to a low-income family.The public housing unit:

A)is provided by the government at a cost of $TB.
B)allows the family to reach a higher indifference curve but causes the family to consume more housing than an equal-sized cash transfer.
C)increases the level of housing consumption by the same amount as an equal-sized cash transfer.
D)causes the family to consume less housing than before the fixed-quantity subsidy.

Question 39

A fixed-quantity subsidy differs from food stamps in that:

A)the fixed-quantity provides a minimum quantity that can be supplemented by additional consumer purchases while additional quantities cannot be purchased with food stamps.
B)the fixed-quantity subsidy increases consumer welfare more than food stamps.
C)the fixed-quantity subsidy cannot be supplemented by additional purchases while the consumer can purchase additional quantities with food stamps.
D)the fixed-quantity subsidy cannot move consumers to a higher indifference curve unlike food stamps.

Question 40

An increase in the price per unit for trash disposal from zero to a positive quantity causes the budget line to change from:

A)a vertical line to a horizontal line.
B)having a zero slope to a negative slope.
C)having a negative slope to a positive slope.
D)a horizontal line to a vertical line.

Question 41

Suppose consumption in year 2 (C₂)is on the horizontal axis and consumption in year 1 (C₁)is on the vertical axis.An increase in the interest rate:

A)makes borrowers better off and lenders worse off.
B)causes more people to shift their consumption from year 2 to year 1.
C)causes the budget line to rotate outward along the horizontal axis.
D)will reduce savings in year 2.

Question 42

For a risk-loving individual,with return on the X-axis and total utility on the Y-axis,the slope of the total utility curve:

A)increases at an increasing rate.
B)has a constant slope.
C)increases at a decreasing rate.
D)decreases at an increasing rate.

Question 43

In a two-year period,if a higher interest rate causes consumption in year 1 to rise:

A)the income effect associated with the higher interest rate is greater than the substitution effect.
B)the substitution effect associated with the higher interest rate is greater than the income effect.
C)the income effect of the higher interest rate is negative.
D)the substitution effect of the higher interest rate is positive.

Question 44

In the intertemporal consumer choice model,an increase in _____ will alter the slope of the budget line.

A)saving
B)the interest rate
C)future income
D)borrowing

Question 45

Consider a two-year period where a consumer has an income of $10,000 in year 1 and $8,000 in year 2.The consumer can borrow or lend at a rate of 10 percent.If the consumer decides to save $1,000 in year 1,it means:

A)his consumption will be equal in both years.
B)he will have a higher consumption in year 2 than in year 1.
C)he considers consumption in year 1 as an inferior good.
D)the cost of future consumption will increase.

Question 46

The expected utility from an investment is defined as _____.

A)the summed value of each possible utility weighted by its probability
B)the expected returns from an investment weighted by its risk.
C)the expected probability of high returns on an investment
D)the summed value of each possible rate of return discounted for inflation

Question 47

An individual is considering consumption in two periods.He has decided to borrow $1,000 in period 1,given his endowment and the interest rate.Other things remaining the same,if the interest rate increases,he will:

A)borrow less than $1,000.
B)continue to borrow $1,000.
C)borrow more than $1,000.
D)borrow more or less depending upon whether or not the substitution effect of the change is greater than the income effect.

Question 48

A reduction in an individual's future income will cause:

A)consumption to fall in both time periods because consumption in both years are normal goods.
B)a fall in consumption in the future period but not the current period since the price of future consumption relative to current consumption did not change.
C)consumption to fall in the future period and rise in the current period as the consumer substitutes more current consumption for the future consumption.
D)an increase in current consumption if interest rates are high enough to induce consumption.

Question 49

When comparing T-bills and stocks,a risk-averse investor may choose to invest in T-bills although stocks give higher average returns because _____.

A)investing in stocks involves a long term commitment
B)investing in stocks involves a higher degree of risk
C)stocks are less liquid than T-bills
D)stocks cannot be bought and sold in a secondary market

Question 50

Expected return is defined as _____.

A)the summed value of each possible rate of return discounted for inflation
B)the average probability of profit on a fair investment
C)the expected probability of high returns on an investment
D)the summed value of each possible rate of return weighted by its probability

Question 51

Fred is considering consumption between two periods and is earning an income of $1,000 in both periods.If the interest rate is 8 percent,Fred borrows $500,but if the interest rate rises to 18 percent,Fred saves $500.Is this behavior economically reasonable?

A)No,Fred would borrow less because of the higher interest rate but would still borrow a positive amount.
B)No,Fred might not borrow at all,but would not start saving.If Fred wanted to save he would have saved at the lower interest rate too.
C)Yes,the change in interest rates will cause his endowment point to shift,allowing him to become a saver.
D)Yes,the higher interest rate will raise the cost of current consumption,inducing him to cut back current consumption.He could cut back so much that he becomes a saver.

Question 52

Consider the income and consumption of an individual between two time periods.If consumption in period 2 (C₂)is on the horizontal axis,consumption in period 1 (C₁)is on the vertical axis,and the interest rate is 11 percent,the slope of the budget constraint must be _____.

A)0.11
B)0.9
C)1.11
D)11

Question 53

Suppose Microsoft stock will provide either a return of 10 or 20 percent over the next year and that the probability of the former outcome is 0.25 while the probability of the latter is 0.75.If the utility an investor derives from a 10 percent return on Microsoft stock is 200 and the utility the investor derives from a 20 percent return is 400,the investor's expected utility from holding Microsoft stock is _____.

A)300
B)350
C)250
D)400

Question 54

Brenda starts a business for $150,000 that gives her a 50% chance of losing and a 50% chance of gaining an expected annual return of $75,000.John is content with a job that pays him $75,000 per year with near certainty;there is only about a 1% chance of losing his job each year.Suppose risk is on the horizontal axis and return on the vertical axis,Brenda's indifference curve for risk and return:

A)is flatter than John's.
B)is steeper than John's.
C)has the same slope as John's.
D)is horizontal.

Question 55

Other things remaining the same,in the intertemporal consumer choice model a change in the endowment point:

A)produces a parallel shift in the consumer's budget line.
B)alters the relative cost of future and present consumption.
C)pivots the budget line.
D)reduces the cost of current consumption.

Question 56

In a two-year period,suppose Gloria has $10,000 in income in year 1 and $4,300 in income in year 2.In order to maintain her optimal consumption of $8,000 in year 1 and $6,500 in year 2,she can borrow or lend at a rate of 10 percent.If Gloria's income stream changes such that she earns $3,000 in Year 1 and $12,000 in Year 2,the budget line will:

A)shift out away from the origin.
B)pivot about the endowment point.
C)pivot about the intercept on the axis representing year 2 income.
D)remain unchanged.

Question 57

Suppose Microsoft stock will provide either a return of 10 or 20 percent over the next year and that the probability of the former outcome is 0.25 while the probability of the latter is 0.75.The expected return on Microsoft stock over the next year is thus _____%.

A)15
B)12.5
C)17.5
D)20

Question 58

For a risk-averse individual,with return on the X-axis and total utility on the Y-axis,the slope of the total utility curve:

A)increases at an increasing rate.
B)has a constant slope.
C)increases at a decreasing rate.
D)is always negative.

Question 59

Consider an individual for whom consumption in two periods is a normal good.Other things remaining the same,if the interest rate increases,then:

A)he is worse off.
B)he is better off.
C)he will spend more in each period.
D)he will choose to save more.

Question 60

An individual who is considering consumption between two time periods (year 1 and year 2)has an endowment of $20,000 in year 1 and $15,000 in year 2.If the interest rate is 5 percent,what is the maximum approximate amount that can be spent on consumption in year 1?

A)$35,000
B)$20,000
C)$35,750
D)$34,250

Question 61

Describe the relationship among total utility,marginal utility,and preferences toward risk.

Question 62

A risk-averse individual _____.

A)prefers a sure return to an uncertain prospect generating the same expected return
B)is indifferent between a sure return and an uncertain prospect generating the same expected return
C)will forgo a sure return in favor of an uncertain prospect generating the same expected return
D)will avoid all risky investments no matter what the return

Question 63

The government of Lilliput wants to ensure food security for all its citizens.Explain how each of these policies will affect the consumption of food and other goods using indifference curves.
a)Providing each Lilliputian with a food voucher for $50
b)Transferring $50 in cash to each Lilliputian's bank account
c)Subsidizing the price of food with a per-unit subsidy
d)Providing $50 worth of food per head free of cost at government-run food agencies.(Assume that an individual cannot supplement this quantity with any extra food)

Question 64

A risk-neutral individual _____.

A)prefers a sure return to an uncertain prospect generating the same expected return
B)is indifferent between a sure return and an uncertain prospect generating the same expected return
C)will forgo a sure return in favor of an uncertain prospect generating the same expected return
D)will avoid all risky investments no matter what the return

Question 65

Show and explain why substituting an unrestricted cash transfer for an excise subsidy of equal cost to the government must lead to less consumption of the subsidized good and more consumption of other goods.

Question 66

Consider Figure 5-6.The family shown faces the budget line A₁BFZ.Health insurance is measured in $100 units and other goods in $1 units.A health insurance plan is introduced which would provide this family $15,000 worth of insurance for $4,000.The new budget constraint the family will face is:

A)AA'Z'
B)AA₁BA'Z'
C)A₁BA'Z'
D)A₁A₂BA'Z'

Question 67

A risk-averse individual who owns a $200,000 house and faces the prospect that the house will burn down with the probability 0.05 in any given year will be willing to pay how much of an annual premium to fully insure against such a loss?

A)$5,000
B)More than $10,000
C)No more than $5,000
D)Either more or less than $10,000 depending on whether housing is a normal or inferior good for the individual

Question 68

Phil and Jane,and their son Dylan,have $10,000 in savings which they would like to invest.Phil wants to use the money to open a diner although he has only a 30% chance of getting the same returns as Jane who prefers investing the money in Treasury bills.Jane prefers to invest in T-bills since they are less risky.Their son,Dylan,is indifferent between the diner and Treasury bills as long as he gets a new car.How would you represent their preferences towards risk and return on an indifference map?

Question 69

Fun-day,a theme park,recently changed its ticket pricing plan from Plan 1 to Plan 2.How would you explain the sudden increase in the number of people at the theme park?

Question 70

Walter works for a large firm that produces software and has a capitalized value of $10 billion.This firm pays its employees,in part,with the company's stock,compensating Walter an additional thirty percent of his $50,000 annual salary worth of the company's stock.Which of the following is true?

A)This compensation scheme reduces the level of risk in his portfolio since he is employed at the same company.
B)This compensation scheme provides Walter a good means of minimizing financial risk since he can hold stock in his company rather than money in the bank.
C)To reduce his exposure to risk Walter should purchase more stock in his company if he believes more people will buy computers in the future.
D)To minimize risk Walter should sell the stock in his company and buy other assets to diversify his financial holdings.

Question 71

In the model of inter-temporal choice,will a person who initially consumes exactly their income in each period have more or less current consumption after a decrease in the interest rate?

Question 72

Which of the following leads to the diversification of risk?

A)Investing in assets that give the highest possible returns
B)Investing in safe assets that may give low returns
C)Investing in multiple assets rather than a single asset
D)Investing in assets that are highly risky but give high returns

Question 73

For a risk-neutral individual,with return on the X-axis and total utility on the Y-axis,slope of the total utility curve:

A)increases at an increasing rate.
B)has a constant slope.
C)increases at a decreasing rate.
D)decreases at an increasing rate.

Question 74

Answer the following:
a)Sarah drives 6 miles to work every day.Liam takes the same route but has to drive for a total of 11 miles.With the objective of reducing traffic jams,the government decides to impose a tax on drivers.How would an annual fixed payment of $500 as congestion charges affect Sarah and Liam? Explain your answer using indifference curves and a common budget line for Liam and Sarah.
b)What if the government decided to impose a fee of $1 per mile driven?

Question 75

Answer the following:
a)How is insurance similar to an individual's diversified portfolio?
b)Explain why holding a diverse portfolio of assets is important to minimizing the risk of an investment portfolio.
c)Given the importance of diversifying all of your financial assets,is it a good idea to own stock in the company for which you work,even if you own stock in other sectors? Explain why or why not.
d)A home is the most valuable asset for a majority of U.S.residents.Why do we not see more diversification in real estate ownership against loss of value due to market fluctuations?