Question 1

The equivalent variation is always less than the consumer's income

Accepted Answer

A) True 
 B)False  True

Question 2

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.

Accepted Answer

a.Ed's optimization problem is Max V²M Subject to p_MM + 200V = 1500 where p_M is the price of meals.Using the Lagrangian,we derive the demand for meals: M* = 500/p_M The change in consumer surplus is found from the integral: ∆CS = ∫₅₀⁷⁵ 500/p_Mdp_M = -500 ln(p_M)|₅₀⁷⁵ = -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 p_M = 75.The Lagrangian is: L = 75M + 200V + [250 - V²M] The optimization conditions are: L_M = 75 - V² = 0 L_V = 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. 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: L_M = 50 - V² = 0 L_V = 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.

Question 3

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.

Accepted 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,2X²= 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.

Question 4

The price of leisure

Accepted Answer

A)  is the same for everyone.
B)  depends on the number of hours worked.
C)  is measured as foregone earnings.
D)  is immeasurable.

Question 5

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.

Accepted Answer

The answer of Suppose a consumer purchases Food (F)and other...

Question 6

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?

Accepted Answer

A)  zero
B)  $15
C)  positive
D)  negative

Question 7

In response to an increase in the wage rate,the income effect will usually cause a person to

Accepted Answer

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.

Question 8

If Bobby thinks that leisure is an inferior good,then his labor supply curve

Accepted Answer

A)  is backward bending.
B)  is always negatively sloped.
C)  is always positively sloped.
D)  does not exist.

Question 9

A backward-bending labor supply curve implies that

Accepted Answer

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.

Question 10

If workers are in the backward-bending section of their labor supply curves,than an increase in the income tax rate will

Accepted Answer

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.

Question 11

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

Accepted Answer

A)  $5,000.
B)  $15,000.
C)  $20,000.
D)  not able to be calculated from the information given.

Question 12

An increase in unearned income always creates a disincentive to work

Accepted Answer

A) True 
 B)False

Question 13

Consumer surplus from a given purchase is the difference between what one was willing to pay for that purchase and what was actually paid.

Accepted Answer

A) True 
 B)False

Question 14

A tax cut that raises the after-tax wage rate will most likely result in more hours worked if

Accepted Answer

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.

Question 15

Suppose a person's utility for leisure (L)and consumption (Y)can be expressed as U = Y + L^0.5.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.

Accepted Answer

The answer of Suppose a person's utility for leisure (L)and...

Question 16

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

Accepted Answer

A)  less than $5.
B)  at least $95.
C)  at least $100.
D)  $105.

Question 17

Consumers who are more sensitive to changes in price suffer a greater loss of consumer surplus from any given price increase.

Accepted Answer

A) True 
 B)False

Question 18

Consider a consumer with preferences for consumption of a composite good (C)and leisure (L)given by the following utility function: U(C,L)= 2C^1/2 + 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?

Accepted Answer

The answer of Consider a consumer with preferences for consumption...

Question 19

A backward-bending labor supply curve could possibly imply which of the following cases?

Accepted Answer

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.

Question 20

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

Accepted Answer

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.

Exam 5: Consumer Welfare and Policy Analysis

The equivalent variation is always less than the consumer's income

The price of leisure

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?

In response to an increase in the wage rate,the income effect will usually cause a person to

If Bobby thinks that leisure is an inferior good,then his labor supply curve

A backward-bending labor supply curve implies that

If workers are in the backward-bending section of their labor supply curves,than an increase in the income tax rate will

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

An increase in unearned income always creates a disincentive to work

Consumer surplus from a given purchase is the difference between what one was willing to pay for that purchase and what was actually paid.

A tax cut that raises the after-tax wage rate will most likely result in more hours worked if

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.

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

Consumers who are more sensitive to changes in price suffer a greater loss of consumer surplus from any given price increase.

A backward-bending labor supply curve could possibly imply which of the following cases?

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

Suppose a person's utility for leisure (L)and consumption (Y)can be expressed as U = Y + L^0.5.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.