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<< Molecular Biology Principles And Practice 2nd ed by Micheal Cox-Test Bank | Microsoft Office Access 2013 Complete In Practice 1st Edition By Annette Easton and Randy Nordell -Test Bank >> |

*Microeconomics***, 8e (Pindyck/Rubinfeld)**

**Chapter 4 Individual and Market Demand**

** **

**4.1 Individual Demand**

** **

1) As we move downward along a demand curve for apples,

- A) consumer well-being decreases.
- B) the marginal utility of apples decreases.
- C) the marginal utility of apples increases.
- D) Both A and B are true.
- E) Both A and C are true.

Answer: B

Diff: 1

Section: 4.1

2) The change in the price of one good has no effect on the quantity demanded of another good. These goods are:

- A) complements.
- B) substitutes.
- C) both inferior.
- D) both Giffen goods.
- E) none of the above

Answer: E

Diff: 1

Section: 4.1

3) The price of good A goes up. As a result the demand for good B shifts to the left. From this we can infer that:

- A) good A is a normal good.
- B) good B is an inferior good.
- C) goods A and B are substitutes.
- D) goods A and B are complements.
- E) none of the above

Answer: D

Diff: 1

Section: 4.1

4) An individual demand curve can be derived from the __ __________ curve.

- A) price-consumption
- B) price-income
- C) income-substitution
- D) income-consumption
- E) Engel

Answer: A

Diff: 1

Section: 4.1

5) Which of the following claims is true at each point along a price-consumption curve?

- A) Utility is maximized but income is not all spent.
- B) All income is spent, but utility is not maximized.
- C) Utility is maximized, and all income is spent.
- D) The level of utility is constant.

Answer: C

Diff: 1

Section: 4.1

6) Which of the following is true regarding income along a price-consumption curve?

- A) Income is increasing.
- B) Income is decreasing.
- C) Income is constant.
- D) The level of income depends on the level of utility.

Answer: C

Diff: 2

Section: 4.1

7) Which of the following is true regarding utility along a price-consumption curve?

- A) It is constant.
- B) It changes from point to point.
- C) It changes only if income changes.
- D) It changes only for normal goods.

Answer: B

Diff: 2

Section: 4.1

8) The income-consumption curve

- A) illustrates the combinations of incomes needed with various levels of consumption of a good.
- B) is another name for income-demand curve.
- C) illustrates the utility-maximizing combinations of goods associated with every income level.
- D) shows the utility-maximizing quantity of some good (on the horizontal axis) as a function of income (on the vertical axis).

Answer: C

Diff: 1

Section: 4.1

9) Which of the following pairs of goods are NOT complements?

- A) Hockey sticks and hockey pucks
- B) Computer CPUs and computer monitors
- C) On-campus student housing and off-campus rental apartments
- D) all of the above
- E) none of the above

Answer: C

Diff: 1

Section: 4.1

10) Which of the following goods has a low, but positive, income elasticity of demand?

- A) furniture.
- B) new cars.
- C) health insurance.
- D) all of the above
- E) none of the above

Answer: C

Diff: 1

Section: 4.1

11) The curve in the diagram below is called

- A) the price-consumption curve.
- B) the demand curve.
- C) the income-consumption curve.
- D) the Engel curve.
- E) none of the above

Answer: A

Diff: 1

Section: 4.1

12) The curve in the diagram below is called:

- A) the price-consumption curve.
- B) the demand curve.
- C) the income-consumption curve.
- D) the Engel curve.
- E) none of the above

Answer: D

Diff: 1

Section: 4.1

13) If an Engel curve has a positive slope

- A) both goods are normal.
- B) the good on the horizontal axis is normal
- C) as the price of the good on the horizontal axis increases, more of both goods in consumed.
- D) as the price of the good on the vertical axis increases, more of the good on the horizontal axis is consumed.

Answer: B

Diff: 1

Section: 4.1

14) Which of the following pairs of goods are substitutes?

- A) Baseball bats and baseballs
- B) Hot dogs and mustard
- C) Computer hardware and software
- D) Gasoline and motor oil
- E) Owner-occupied housing and rental housing

Answer: E

Diff: 1

Section: 4.1

15) When the income-consumption curve has a positive slope throughout its entire length, we can conclude that

- A) both goods are inferior.
- B) both goods are normal.
- C) the good on the vertical (y) axis is inferior.
- D) the good on the horizontal (x) axis is inferior.

Answer: B

Diff: 2

Section: 4.1

16) Use the following statements to answer this question:

- A price-consumption curve is derived by varying the price of asparagus. If the price-consumption curve is an upward sloping straight line, the demand curve for asparagus must be downward sloping.
- Fred consumes only food and clothing. Freds Engel curve traces out the utility maximizing combinations of food and clothing associated with each and every income level.
- A) I and II are true.
- B) I is true, and II is false.
- C) I is false, and II is true.
- D) I and II are false.

Answer: B

Diff: 2

Section: 4.1

17) Consider two goods X and Y available for consumption. Assume that the price of X changes while the price of Y remains fixed. For these two goods, the price-consumption curve illustrates the

- A) relationship between the price of X and consumption of Y.
- B) utility-maximizing combinations of X and Y for each price of X.
- C) relationship between the price of Y and the consumption of X.
- D) utility-maximizing combinations of X and Y for each quantity of X.

Answer: B

Diff: 2

Section: 4.1

18) Consider a graph on which one good Y is on the vertical axis and the only other good X is on the horizontal axis. On this graph the income-consumption curve has a positive slope for low incomes, then it takes a zero slope for a higher income, and then it takes a negative slope for even higher incomes (the curve looks like an arc, first rising and then falling as income increases). This curve illustrates that, for all income levels,

- A) both X and Y are normal.
- B) only Y is normal.
- C) both X and Y are inferior.
- D) only X is normal.

Answer: D

Diff: 2

Section: 4.1

19) According to a survey by the U.S. Bureau of Labor Statistics, which of the following statements about annual U.S. household consumer expenditures is false?

- A) The income elasticity of demand for entertainment is positive.
- B) The income elasticity of demand for owner-occupied housing is positive.
- C) The income elasticity of demand for rental housing is positive.
- D) The income elasticity of demand for health care is positive.
- E) Average family expenditures increase with income.

Answer: C

Diff: 2

Section: 4.1

20) The income-consumption curve for Dana between Qa and Qb is given as: Qa = Qb. His budget constraint is given as:

120 = Qa + 4Qb

How much Qa will Dana consume to maximize utility?

- A) 0
- B) 24
- C) 30
- D) 60
- E) More information is needed to answer this question.

Answer: B

Diff: 3

Section: 4.1

21) Jons income-consumption curve is a straight line from the origin with a positive slope. Now suppose that Jons preferences change such that his income-consumption curve remains a straight line but rotates 15 degrees clockwise. Jons demand curve for the good on the horizontal axis

- A) will shift left.
- B) will shift right.
- C) will not change.
- D) might do any of the above.

Answer: B

Diff: 3

Section: 4.1

22) Suppose that a consumer regards two types of soap as perfect substitutes for one another. The price consumption path generated by changing the price of one type of soap

- A) is always upward sloping.
- B) is always horizontal.
- C) is always vertical.
- D) corresponds with the axis for the cheaper soap.
- E) corresponds with the axis for the more expensive soap.

Answer: D

Diff: 3

Section: 4.1

23) Your income response for bicycle riding changes with the amount of income you earn. At low levels of income, you view bicycle riding as an inferior good and substitute other types of transportation (e.g., auto travel) as your income rises. However, you view bicycle riding as a normal good after your income rises above a particular level. What shape does your Engel curve for bicycle riding have?

- A) Vertical line
- B) Horizontal line
- C) C-shaped
- D) Upward sloping
- E) none of the above

Answer: C

Diff: 1

Section: 4.1

24) Use the following statements to answer this question:

- The income-consumption curve for perfect complements is a straight line.
- The price-consumption curve for perfect complements is a straight line.
- A) I and II are true.
- B) I is true and II is false.
- C) II is true and I is false.
- D) I and II are false.

Answer: A

Diff: 2

Section: 4.1

25) As a group, U.S. consumers view hamburger as a normal good at low income levels and as an inferior good at high income levels. Based on this information, which of the following statements is NOT true?

- A) As income for all consumers rises, the hamburger demand curves of low-income consumers shift rightward, and the demand curves of high-income consumers shift leftward.
- B) The aggregate demand curve for hamburger in the U.S. is upward sloping at low prices.
- C) The Engel curve for hamburger consumed in the U.S. is upward sloping at low income levels and downward sloping at high income levels.
- D) The income-consumption curve for hamburger and all other food products cannot be a straight line.

Answer: B

Diff: 1

Section: 4.1

26) Suppose the income-consumption curve for goods X and Y is upward sloping. If the price of good Y increases and the income-consumption curve rotates in clockwise fashion, then we know that:

- A) X and Y are complements.
- B) X and Y are both inferior goods.
- C) X and Y are substitutes .
- D) Y is an inferior good.

Answer: C

Diff: 2

Section: 4.1

27) In the diagram below, Marvins optimal consumption bundles are indicated for five different budget constraints. Sketch the Engel curve for Marvin. Next, use the diagram to sketch Marvins demand curve for the good on the horizontal axis.

Answer: To construct the Engel curve, the relevant budget constraints are 3, 4 and 5. The Engel curve will be increasing in income and quantity space. To construct the demand curve, the relevant budget constraints are 1,2 and 3. Demand for good 1 increases as the price decreases.

Diff: 2

Section: 4.1

28) Melissas optimal consumption is indicated in the diagram below for three different income levels. For Melissa are park visits a normal or inferior good? Explain your answer.

Answer: Melissas demand behavior exhibited above suggests that as her income rises, she demands fewer park visits. Since the income effect is negative, park visits are an inferior good for Melissa.

Diff: 1

Section: 4.1

29) Using the table below, construct an Engel Curve for each beer type.

Answer:

Diff: 1

Section: 4.1

** **

**4.2 Income and Substitution Effects**

** **

1) Based on the diagram below it can be inferred that:

- A) hot dogs are a normal good for all levels of income.
- B) hot dogs are an inferior good, but not a Giffen good, for all levels of income.
- C) hot dogs are a Giffen good for all levels of income.
- D) hot dogs are an inferior good for low levels of income, but at higher levels of income become a normal good.
- E) none of the above

Answer: E

Diff: 2

Section: 4.2

2) Good A is a normal good. The demand curve for good A:

- A) slopes downward.
- B) usually slopes downward, but could slope upward.
- C) slopes upward.
- D) usually slopes upward, but could slope downward.

Answer: A

Diff: 1

Section: 4.2

3) Use the following two statements in answering this question:

- All Giffen goods are inferior goods.
- All inferior goods are Giffen goods.
- A) I and II are true.
- B) I is true, and II is false.
- C) I is false, and II true.
- D) I and II are false.

Answer: B

Diff: 1

Section: 4.2

4) The change in the quantity demanded of a good resulting from a change in relative price with the level of satisfaction held constant is called the ________ effect.

- A) Giffen
- B) real price
- C) income
- D) substitution

Answer: D

Diff: 1

Section: 4.2

5) For an inferior good, the income and substitution effects

- A) work together.
- B) work against each other.
- C) can work together or in opposition to each other depending upon their relative magnitudes.
- D) always exactly cancel each other.

Answer: B

Diff: 1

Section: 4.2

6) The substitution effect of a price change for product X is the change in consumption of X associated with a change in

- A) the price of X, with the level of utility held constant.
- B) the price of X, with the level of real income not considered.
- C) the price of X, with the prices of other goods changing by the same percentage as that for product X.
- D) income, with prices of other goods held constant.

Answer: A

Diff: 1

Section: 4.2

7) A Giffen good

- A) is always the same as an inferior good.
- B) is the special subset of inferior goods in which the substitution effect dominates the income effect.
- C) is the special subset of inferior goods in which the income effect dominates the substitution effect.
- D) must have a downward sloping demand curve.

Answer: C

Diff: 1

Section: 4.2

8) Which of the following is true concerning the substitution effect of a decrease in price?

- A) It will lead to an increase in consumption only for a normal good.
- B) It always will lead to an increase in consumption.
- C) It will lead to an increase in consumption only for an inferior good.
- D) It will lead to an increase in consumption only for a Giffen good.

Answer: B

Diff: 1

Section: 4.2

9) Which of the following is true concerning the income effect of a decrease in price?

- A) It will lead to an increase in consumption only for a normal good.
- B) It always will lead to an increase in consumption.
- C) It will lead to an increase in consumption only for an inferior good.
- D) It will lead to an increase in consumption only for a Giffen good.

Answer: A

Diff: 1

Section: 4.2

10) Which of the following describes the Giffen good case? When the price of the good

- A) rises, the income effect is opposite to and greater than the substitution effect, and consumption falls.
- B) falls, the income effect is in the same direction as the substitution effect, and consumption rises.
- C) falls, the income effect is in the opposite direction to the substitution effect, and consumption falls.
- D) falls, the income effect is in opposite direction to the substitution effect and consumption rises.
- E) Both A and D are correct.

Answer: C

Diff: 3

Section: 4.2

11) Use the following two statements in answering this question:

- For all Giffen goods the substitution effect is larger than the income effect.
- For all inferior goods the substitution effect is larger than the income effect.
- A) I and II are true.
- B) I is true, and II is false.
- C) I is false, and II is true.
- D) I and II are false.

Answer: D

Diff: 2

Section: 4.2

12) Assume that beer is a normal good. If the price of beer rises, then the substitution effect results in the person buying ________ of the good and the income effect results in the person buying ________ of the good.

- A) more, more
- B) more, less
- C) less, more
- D) less, less

Answer: D

Diff: 2

Section: 4.2

13) Assume that beer is an inferior good. If the price of beer falls, then the substitution effect results in the person buying ________ of the good and the income effect results in the person buying ________ of the good.

- A) more, more
- B) more, less
- C) less, more
- D) less, less

Answer: B

Diff: 2

Section: 4.2

14) Good A is an inferior good. If the price of good A were to suddenly double, the substitution effect would cause the purchases of good A to increase by

- A) more than double.
- B) exactly double.
- C) less than double.
- D) Any of the above are possible.
- E) none of the above

Answer: E

Diff: 2

Section: 4.2

15) Good A is a Giffen good. If the price of good A were to suddenly double, the income effect would cause the purchases of good A to increase by

- A) more than double.
- B) exactly double.
- C) less than double.
- D) Any of the above are possible.
- E) none of the above

Answer: D

Diff: 2

Section: 4.2

**Figure 4.1**

A consumers original utility maximizing market basket of goods is shown in Figure 4.1 as point A. Following a price change, the consumers utility maximizing market basket changes is at point B.

16) Refer to Figure 4.1. The substitution effect of the price change in food on the quantity of food purchased is:

- A) the change from F3 to F1.
- B) the change from F3 to F2.
- C) the change from F2 to F1.
- D) the change from F1 to F2.
- E) none of the above

Answer: B

Diff: 2

Section: 4.2

17) Refer to Figure 4.1. The income effect of the price change in food on the quantity of food purchased is:

- A) the change from F3 to F1.
- B) the change from F3 to F2.
- C) the change from F2 to F1.
- D) the change from F1 to F2.
- E) none of the above

Answer: C

Diff: 2

Section: 4.2

18) Based on Figure 4.1, food is:

- A) a normal good.
- B) an inferior good, but not a Giffen good.
- C) a Giffen good.
- D) none of the above

Answer: A

Diff: 2

Section: 4.2

**Figure 4.2**

A consumers original utility maximizing market basket of goods is shown in Figure 4.2 as point A. Following a price change, the consumers utility maximizing market basket is at point B.

19) Refer to Figure 4.2. The substitution effect on the quantity of clothing purchased is:

- A) the change from C3 to C1.
- B) the change from C3 to C2.
- C) the change from C2 to C1.
- D) the change from C1 to C2.
- E) none of the above

Answer: D

Diff: 2

Section: 4.2

20) Refer to Figure 4.2. The income effect on the quantity of clothing purchased is:

- A) the change from C1 to C3.
- B) the change from C1 to C2.
- C) the change from C2 to C3.
- D) the change from C3 to C2.
- E) none of the above

Answer: C

Diff: 2

Section: 4.2

21) Based Figure 4.2, clothing is:

- A) a normal good.
- B) an inferior good, but not a Giffen good.
- C) a Giffen good.
- D) none of the above

Answer: A

Diff: 2

Section: 4.2

__Scenario 4.1:__

Daniel derives utility from only two goods, cake (Qc) and donuts (Qd). The marginal utility that Daniel receives from cake (MUc) and donuts (MUd) are given as follows:

MUc = Qd MUd = Qc

Daniel has an income of $240 and the price of cake (Pc) and donuts (Pd) are both $3.

22) See Scenario 4.1. What is Daniels budget constraint?

- A) 240 = 3Pc + 3Pd
- B) 240 = 3Qc + 3Qd
- C) 240 = (Pc)(Qc)
- D) 240 = (Qc)(Qd)
- E) none of the above

Answer: B

Diff: 2

Section: 4.2

23) See Scenario 4.1. What is Daniels income-consumption curve?

- A) Pc = Pd
- B) Pc = Qc
- C) Qd = I 3Qc
- D) Qc = Qd
- E) all of the above

Answer: D

Diff: 3

Section: 4.2

24) See Scenario 4.1. What quantity Qc will maximize Daniels utility given the information above?

- A) 0
- B) 24
- C) 40
- D) 60
- E) none of the above

Answer: C

Diff: 3

Section: 4.2

25) See Scenario 4.1. Holding Daniels income and Pd constant at $240 and $3 respectively, what is Daniels demand curve for cake?

- A) Qc = 240 Pc
- B) Qc = 240/Pc
- C) Qc = 120/Pc
- D) Qc = 240/(3 + Pc)
- E) none of the above

Answer: D

Diff: 3

Section: 4.2

26) You have just won a cash award of $500 for academic excellence.

- A) The substitution effect of this award will be larger than its income effect.
- B) The income effect of this award will be larger than its substitution effect.
- C) The substitution and income effects will be of identical size.
- D) It is impossible to know whether the substitution effect is larger than the income effect or vice versa.

Answer: B

Diff: 3

Section: 4.2

27) The Russian government wants to reduce the consumption of vodka. A one hundred rouble tax on each bottle purchased may reduce the consumption of vodka under which circumstance(s)?

- A) Vodka is an inferior good.
- B) Vodka is a normal good.
- C) Vodka is an inferior good and the taxes collected from this tax are rebated to consumers.
- D) Vodka is a normal good and the taxes collected from this tax are rebated to consumers.
- E) both B and C

Answer: E

Diff: 3

Section: 4.2

28) Suppose the price of rice increases and you view rice as an inferior good. The substitution effect results in a ________ change in rice consumption, and the income effect leads to a ________ change in rice consumption.

- A) positive, positive
- B) positive, negative
- C) negative, positive
- D) negative, negative

Answer: C

Diff: 1

Section: 4.2

29) Your indifference curves for good X (horizontal axis) and good Y (vertical axis) are vertical lines because you do not gain any satisfaction from consumption of Y. As the price of X declines, the change in consumption of X is entirely composed of the:

- A) income effect.
- B) substitution effect.
- C) Giffen effect.
- D) independent good effect.

Answer: A

Diff: 2

Section: 4.2

30) Suppose you only consume rice and bananas. Can both of these goods be Giffen goods in your consumption?

- A) Yes, this is possible
- B) No, at least one of the goods must be normal
- C) No, they both can be inferior, but at least one of the goods cannot be a Giffen good
- D) We need more information about the goods to answer this question

Answer: B

Diff: 1

Section: 4.2

31) As a group, U.S. consumers have no income response for their consumption of ice cream so that the income elasticity of demand for ice cream equals zero. Does this mean that the change in ice cream consumption that results from a price increase is entirely composed of the substitution effect?

- A) Yes, the income effect associated with a price change is zero
- B) No, any price change moves the point of consumption to a new indifference curve, so there must be a non-zero income effect
- C) No, the income and substitution effects in this case move in opposite directions and completely offset one another, so it only appears that the income effect is zero
- D) We need more information about the goods to answer this question

Answer: A

Diff: 2

Section: 4.2

32) If the marginal rate of substitution is infinite or zero, show that the substitution effect of a price change for a good is zero.

Answer:

Suppose that the consumer has budget constraint BC1 shown above. If the consumers MRS is infinite as indicated above as I1, the optimal bundle involves consuming a positive quantity of only good 1. If the price of good 1 falls, the consumers new budget constraint becomes BC2. The optimal consumption bundle at new prices holding utility constant at I1 is the same. Thus, there is no substitution effect.

If the consumers MRS is zero as indicated above on indifference curve I0, the optimal bundle involves consuming a positive quantity of only good 2. If the price of good 1 falls, the consumers new budget constraint again becomes BC2. On this new budget constraint, the optimal bundle does not change. Thus, there is no substitution or income effect.

Another possibility is to have certain portions of the indifference curve exhibit either zero or infinite MRS as indicated directly above. The indifference curve Ipc suggests the goods are perfect complements. At initial prices, the consumers optimal choice is at point A on BC1 and Ipc. When the price of good 1 falls, we see that the optimal consumption bundle holding utility constant at new prices doesnt change. Thus, there is no substitution effect.

Diff: 3

Section: 4.2

33) Suppose the marginal rate of substitution is constant at 6 for all possible consumption bundles. Next suppose that the price of good 1 decreases, and the ratio P1/P2 is greater than 6. Show that the income and substitution effects from this price change are both zero.

Answer:

When the price of good 1 falls, the price ratio is still greater than 6 and the slope of the new budget constraint (BC2) must be flatter than the slope of the original budget constraint (BC1). Since the MRS is exactly 6, the consumer maximizes utility by consuming as much of good 2 as possible. After the price change, the consumer chooses the same bundle. Thus, the substitution and income effects are both zero in this example.

Diff: 2

Section: 4.2

34) Donald derives utility from only two goods, carrots (Qc) and donuts (Qd). His utility function is as follows:

U(Qc,Qd) = (Qc)(Qd)

The marginal utility that Donald receives from carrots (MUc) and donuts (MUd) are given as follows:

MUc = Qd MUd = Qc

Donald has an income (I) of $120 and the price of carrots (Pc) and donuts (Pd) are both $1.

- What is Donalds budget line?
- What is Donalds income-consumption curve?
- What quantities of Qc and Qd will maximize Donalds utility?
- Holding Donalds income and Pd constant at $120 and $1 respectively, what is Donalds demand curve for carrots?
- Suppose that a tax of $1 per unit is levied on donuts. How will this alter Donalds utility maximizing market basket of goods?
- Suppose that, instead of the per unit tax in (e), a lump sum tax of the same dollar amount is levied on Donald. What is Donalds utility maximizing market basket?
- The taxes in (e) and (f) both collect exactly the same amount of revenue for the government, which of the two taxes would Donald prefer? Show your answer numerically and explain why Donald prefers the per unit tax over the lump sum tax, or vice versa, or why he is indifferent between the two taxes.

Answer:

*a.*

Budget line: 120 = Qc + Qd

The income consumption curve must satisfy:

MUd/MUc = Pd/Pc

Substituting for MUd, MUc, Pd, and Pc yields:

Qc/Qd = 1 or Qc = Qd

Substituting the information in (b) into the budget line:

120 = Qc + Qc = 2Qc

Qc = 60

Qd = 60

Rewriting the budget line:

120 = PcQc + Qd

Substituting the information in (b) into the budget line:

120 = PcQc + Qc = Qc(Pc + 1)

Qc = 120/(Pc + 1)

The $1 tax on donuts raises the after-tax price to $2. The income-consumption curve becomes:

MUd/MUc = Pd/Pc

Substituting for MUd, MUc, Pd and Pc yields:

Qc/Qd = 2 or Qc = 2Qd

The budget line is:

120 = Qc + 2Qd

Substitute the income-consumption curve into the budget line to eliminate Qc:

120 = 2Qd + 2Q = 4Qd

Qd = 30

Qc = 60

Donald buys 30 donuts, so he pays $30 in tax. If Donald paid $30 in a lump sum tax, his income would be $90. Resolve the utility maximization problem with I = 90, Pc = Pd = 1.

The utility maximizing market basket is Qc = Qd = 45.

Donald prefers the lump-sum tax to the excise tax. Use the utility function to show which market basket is preferred.

U(Qc, Qd) = QcQd

lump-sum tax U(45, 45) = 45 45 = 2,025

excise tax U(60, 30) = 60 30 = 1,800

Diff: 3

Section: 4.2

35) The following data pertain to products A and B, both of which are purchased by Madame X. Initially, the prices of the products and quantities consumed are:

PA = $10, QA = 3, PB = $10, QB = 7.

Madame X has $100 to spend per time period. After a reduction in price of B, the prices and quantities consumed are:

PA = $10, QA = 2.5, PB = $5, QB = 15.

Assume that Madame X maximizes utility under both price conditions above. Also, note that if after the price reduction enough income were taken away from Madame X to put her back on the original indifference curve, she would consume this combination of A and B:

QA = 1.5, QB = 9

- Determine the change in consumption rate of good B due to (1) the substitution effect and (2) the income effect.
- Determine if product B is a normal, inferior, or Giffen good. Explain.

Answer:

The total effect of the price change is the difference in the quantities before and after the price change, or 15 7 = 8. This change of 8 includes the income and substitution effects. The reduction in consumption that resulted from the reduction in income to put Madame X back on the original indifference curve represents the income effect. This difference is

15 9 = 6. The difference between 15 7 = 8 and

15 9 = 6 is the substitution effect, i.e. 8 6 = 2. * *

Since the two effects are additive and both are positive, we have a normal good, i.e., 6 + 2 = 8.

Diff: 3

Section: 4.2

36) The diagram below depicts the change in optimal consumption bundles for Marty when the price of shotgun shells fall. Decompose the change into the income and substitution effects.

Answer:

Diff: 2

Section: 4.2

37) Margarets optimal consumption is shown in the diagram below for two different prices of Hy-Vee Cola. Decompose the change in Hy-Vee Cola consumption into income and substitution effects. Do the effects work in opposite directions?

Answer:

The substitution effect is (*c*2 *c*1). The income effect is (*c*3 *c*2). Note that the income effect is negative. Thus, the income and substitution effects work in opposite directions.

Diff: 2

Section: 4.2

38) The demand curves for steak, eggs, and hot dogs are given in the table below. The current price of steak is $5. The price of eggs is $2.50, and the price of hot dogs is $0.75. Fill in the remaining columns of the table using this information. Indicate which goods are substitutes and which goods are complements.

Good |
Demand Equation |
Steak Price Elasticity of Demand |
Egg Price Elasticity of Demand |
Hotdog Price Elasticity of Demand |

Steak |
DS = 500 2PS PE + PH |
|||

Egg |
DE = 75 3PE PS + PH |
|||

Hotdog |
DH = 300 PH + PS + PE |

** **

** **

** **

Answer:

Good |
Demand Equation |
Steak Price Elasticity of Demand |
Egg Price Elasticity of Demand |
Hotdog Price Elasticity of Demand |

Steak |
DS = 500 2PS PE + PH |
-0.020 | -0.00051 | 1.53 |

Egg |
DE = 75 3PE PS + PH |
-0.079 | -0.24 | 1.20E-4 |

Hotdog |
DH = 300 PH + PS + PE |
0.016 | 0.00082 | -0.0012 |

** **

Steak and eggs are complements. Steak and hotdogs and eggs and hotdogs are substitutes.

Diff: 3

Section: 4.2

** **

**4.3 Market Demand**

** **

1) A consumer spends his income on food and rent. The government places a $1 tax on food. To restore the pre-tax consumption level of food the rebate paid to consumers will be smallest when

- A) the own price elasticity of demand for food is 2, and the income elasticity of demand for food is 5.
- B) the own price elasticity of demand for food is 5, and the income elasticity of demand for food is 5.
- C) the own price elasticity of demand for food is 2, and the income elasticity of demand for food is 10.
- D) the own price elasticity of demand for food is 5, and the income elasticity of demand for food is 10.

Answer: C

Diff: 3

Section: 4.3

2) Price elasticity of demand measures the

- A) slope of the demand curve.
- B) sensitivity of quantity demanded to changes in the price of substitute goods.
- C) sensitivity of price to changes in the quantity demanded of substitute goods.
- D) sensitivity of quantity demanded to changes in price.

Answer: D

Diff: 1

Section: 4.3

3) When a good is price inelastic, consumer expenditures on the good

- A) increase when price increases.
- B) decrease when price increases.
- C) do not change when price increases.
- D) are not related to price elasticity of demand.

Answer: A

Diff: 1

Section: 4.3

4) When a good has a unitary price elasticity, consumer expenditures for the good

- A) change in the same direction as a price change.
- B) change in the opposite direction to a price change, but not necessarily by the same percentage as the price change.
- C) do not change when the price of the good decreases.
- D) change in the opposite direction and by the same percentage as any price change.

Answer: C

Diff: 1

Section: 4.3

5) Recently, Skooterville has experienced a large growth in population. As a result, the demand curve for telephone service in Skooterville:

- A) has shifted to the right.
- B) has shifted to the left.
- C) has shifted down.
- D) Both B and C are correct.
- E) none of the above

Answer: A

Diff: 1

Section: 4.3

6) The demand for sirloin steak is probably more elastic than the demand for all meat because

- A) steak is very expensive.
- B) people are worried about cholesterol.
- C) cattle raising is not very profitable.
- D) there are more substitutes for sirloin steak than for all meats.

Answer: D

Diff: 1

Section: 4.3

7) Which of the following is true about the demand for gasoline?

- A) It is probably more price elastic in the long run because price will increase by a higher percentage.
- B) It is probably more price elastic in the long run because it is easier to find substitutes for gasoline in the long run.
- C) It is probably more price elastic in the short run because price will increase by a higher percentage.
- D) It is probably more price elastic in the short run because it is easier to find substitutes for gasoline in the short run.

Answer: B

Diff: 1

Section: 4.3

8) In a recent article, two economists estimated that the 37.5% increase in price that would result from a 75 cent tax increase on cigarettes would lead to a decrease in smoking among college students of 30%. What can you conclude about the demand for cigarettes among college students?

- A) It is price elastic.
- B) It is price inelastic.
- C) It is unit elastic.
- D) It is perfectly inelastic.

Answer: B

Diff: 1

Section: 4.3

9) As the price of good X increases from $5 to $8, quantity demanded falls from 100 to 80. Based upon this information we can conclude that the demand for X is

- A) elastic.
- B) inelastic.
- C) unit inelastic.
- D) insufficient information for judgment.

Answer: B

Diff: 2

Section: 4.3

10) Use the following two statements to answer this question:

- The price elasticity of demand is constant along the entire length of a linear demand curve.
- The price elasticity of demand is the special name that economists give to the slope of a demand curve.
- A) I and II are true.
- B) I is true, and II is false.
- C) I is false, and II is true.
- D) I and II are false.

Answer: D

Diff: 2

Section: 4.3

11) What is the shape of the total revenue curve derived from a linear downward sloping demand curve?

- A) Horizontal
- B) Vertical
- C) U-shaped
- D) Inverted u-shaped

Answer: D

Diff: 2

Section: 4.3

12) What is the shape of the total revenue curve derived from a horizontal demand curve?

- A) Horizontal
- B) Vertical
- C) U-shaped
- D) Upward sloping, with a positive slope

Answer: D

Diff: 2

Section: 4.3

13) What is the shape of the marginal revenue curve derived from a linear downward sloping demand curve?

- A) Horizontal
- B) Vertical
- C) U-shaped
- D) Downward sloping, with a constant slope

Answer: D

Diff: 3

Section: 4.3

14) Which of the following functions is least likely to represent a real demand curve?

- A) Q = 120 2P
- B) Q = 120 3P + 2I
- C) Q = 120/P
- D) Q = 120 + 3P 2I
- E) Q = 120/(Pa + Pb)

Answer: D

Diff: 2

Section: 4.3

__Scenario 4.2:__

Suppose that the demand for artichokes (Qa) is given as:

Qa = 200 4P

15) Use the information in Scenario 4.2. What is the price elasticity of demand if the price of artichokes is $10?

- A) 0
- B) -0.25
- C) -1
- D) -4
- E) negative infinity

Answer: B

Diff: 2

Section: 4.3

16) Use the information in Scenario 4.2. Suppose that the price of artichokes is increased slightly from $10. The total expenditure by consumers on artichokes will ________ and the number of artichokes sold will ________.

- A) rise, rise
- B) rise, fall
- C) fall, rise
- D) fall, fall

Answer: B

Diff: 2

Section: 4.3

17) Use the information in Scenario 4.2. At what price, if any, is the demand for artichokes completely elastic?

- A) 50
- B) 30
- C) 10
- D) 0
- E) none of the above

Answer: A

Diff: 2

Section: 4.3

__ __

__Scenario 4.3:__

The demand for erasers (Q) is given as follows:

Q = 240 4Pe + 2I + Pb + A

where Pe is the price of erasers

I is the level of income

Pb is the price of another good

A is the level of advertising

Suppose that Q = 240, Pe = 10, Pb = 10, and A = 2.

18) Given the information in Scenario 4.3, determine I.

- A) 0
- B) 14
- C) 24
- D) 36
- E) 48

Answer: B

Diff: 2

Section: 4.3

19) Given the information in Scenario 4.3, what is the point price elasticity of demand?

- A) -1/3
- B) -1/6
- C) -1/10
- D) -1/24
- E) -5/24

Answer: B

Diff: 2

Section: 4.3

20) Given the information in Scenario 4.3, it would be correct to say that demand is:

- A) infinitely elastic.
- B) elastic, but not infinitely elastic.
- C) unit elastic (Ep = -1).
- D) inelastic, but not completely inelastic.
- E) completely inelastic.

Answer: D

Diff: 1

Section: 4.3

21) Given the information in Scenario 4.3, suppose that the price of erasers increases slightly from $10. How will this affect the total revenue collected by the firm?

- A) Total revenue will increase.
- B) Total revenue will not change.
- C) Total revenue will decrease.
- D) There will be an indeterminate change in total revenue.

Answer: A

Diff: 2

Section: 4.3

22) Given the information in Scenario 4.3, erasers are:

- A) a normal good.
- B) an inferior good.
- C) neither normal nor inferior.
- D) complements.
- E) necessities.

Answer: A

Diff: 1

Section: 4.3

23) Given the information in Scenario 4.3, erasers and good b, are:

- A) substitutes.
- B) complements.
- C) completely unrelated.
- D) normal.
- E) inferior.

Answer: A

Diff: 1

Section: 4.3

24) The point price elasticity of demand is -1/2. The price of the product increases from $1.00 to $1.10. Given the information in Scenario 4.3, the quantity demanded will decrease by approximately:

- A) 5 units.
- B) 5 percent.
- C) 10 units.
- D) 10 percent.
- E) none of the above

Answer: B

Diff: 1

Section: 4.3

__ __

__Scenario 4.4:__

The demand curve for the new computer game, Rock and Roll Trivia, is given as follows:

Q = 200 5P .1Pc .5Pd + .2A I

where P is the price of the game

Pc is the price of a computer

Pd is the price of a diskette

A is the level of advertising

Q is the level of income

25) See the information in Scenario 4.4. Does the demand curve for Rock and Roll Trivia slope downward?

- A) Yes it does.
- B) No it does not.
- C) More information is needed to answer this question.

Answer: A

Diff: 1

Section: 4.3

26) See the information in Scenario 4.4. From this demand curve, one can infer that:

- A) Rock and Roll Trivia is an inferior good.
- B) computers and diskettes are substitutes.
- C) computers and diskettes are complements.
- D) computers are a normal good.
- E) A, B and D are true.

Answer: A

Diff: 2

Section: 4.3

27) See the information in Scenario 4.4. From this demand curve, one can infer that:

- A) an increase in advertising will cause an increase in the demand for Rock and Roll Trivia.
- B) Rock and Roll Trivia and computers are substitutes.
- C) Rock and Roll Trivia and diskettes are substitutes.
- D) all of the above
- E) none of the above

Answer: A

Diff: 2

Section: 4.3

28) See the information in Scenario 4.4. Suppose P = 10, Pc = 100, Pd = 2, A = 5, and I = 50. How many games will be sold?

- A) -100
- B) 0
- C) 50
- D) 90
- E) none of the above

Answer: D

Diff: 2

Section: 4.3

29) See the information in Scenario 4.4. Suppose P = 10, Pc = 100, Pd = 2, A = 5, and I = 50. What is the price elasticity of demand?

- A) 0
- B) -5/9
- C) -1
- D) -9/5
- E) none of the above

Answer: B

Diff: 2

Section: 4.3

30) See the information in Scenario 4.4. Suppose that the price should increase slightly from $10, how will this affect the total expenditure of consumers on the game?

- A) Total expenditures will increase.
- B) Total expenditures will not change.
- C) Total expenditures will decrease by a larger percentage than the price increase.
- D) Total expenditures will decrease by a smaller percentage than the price increase.
- E) either C or D could be true.

Answer: A

Diff: 2

Section: 4.3

31) See the information in Scenario 4.4. Suppose P = 10, Pc = 100, Pd = 2, A = 5, and I = 50. What is the income elasticity of demand?

- A) 0
- B) 5/9
- C) 1
- D) 9/5
- E) none of the above

Answer: E

Diff: 3

Section: 4.3

32) See the information in Scenario 4.4. Suppose P = 10, Pc = 100, Pd = 2, A = 5, and I = 50. What is the cross-price elasticity of Rock and Roll Trivia programs and diskettes?

- A) -1/90
- B) 0
- C) 1/90
- D) 1
- E) none of the above

Answer: A

Diff: 2

Section: 4.3

33) A local retailer has decided to carry a well-known brand of shampoo. The marketing department tells them that the quarterly demand by an average man is:

Qd = 3 0.25P

and the quarterly demand by an average woman is:

Qd = 4 0.5P

The market consists of 10,000 men and 10,000 women. How may bottles of shampoo can they expect to sell if they charge $6 per bottle?

- A) 20,000
- B) 33,000
- C) 25,000
- D) 10,000
- E) none of the above

Answer: C

Diff: 2

Section: 4.3

34) General Motors estimates that U.S. demand for its newest product will be: Qus = 30,000 0.5P. Export demand will be Qex = 25,000 0.5P. The total market demand curve for this product will be a

- A) straight line with a slope of -0.5.
- B) straight line with a slope of -1.0.
- C) kinked line with the kink at Q = 25,000.
- D) kinked line with the kink at P = 50,000.
- E) none of the above

Answer: D

Diff: 3

Section: 4.3

35) The point price elasticity of demand for red herring is -4. The demand curve for red herring is: Q = 120 P. What is the price of red herring?

- A) $96
- B) $80
- C) $100
- D) $120
- E) none of the above

Answer: A

Diff: 1

Section: 4.3

36) Consider the following statements when answering this question.

- If no consumer has a kinked demand curve for CDs, then the market demand curve for CDs cannot be kinked either.
- If at a price of $10, every consumer has inelastic demand, then at that price the market demand for CDs will be inelastic too.
- A) I and II are true.
- B) I is true, and II is false.
- C) I is false, and II is true.
- D) I and II are false.

Answer: D

Diff: 3

Section: 4.3

37) To determine whether an increase in the price of gasoline results in a consumer spending a larger share of their expenditure on gasoline we need to know

- A) only how much money the consumer spends on gasoline before the price change
- B) only the change in the price of gasoline
- C) only the change in the price of gasoline as a percentage of the original price
- D) only the own price elasticity of demand for gasoline
- E) none of the above

Answer: D

Diff: 2

Section: 4.3

38) Microsoft wants to calculate the effect of a worldwide 5% price cut on its sales of Excel to clients in different countries. Microsoft sells Excel at different prices in U.S., Japan and Europe. Before the price cut U.S. sales were twice sales in Japan and Europe. If the price of elasticity of demand in the U.S., Japan and Europe are -3, -4, and -2 respectively, the worldwide sales rise by

- A) 10%.
- B) 15%.
- C) 20%.
- D) 25%.
- E) none of the above

Answer: B

Diff: 3

Section: 4.3

39) Gold buyers are located in New York and Zurich. If the price of gold is $400 an ounce, the worldwide demand for gold is 10,000 ounces. Also, the price elasticity of demand for gold in New York and Zurich are -3 and -2 respectively. If the slope of each demand curve in New York is the same as in Zurich, then the quantity of gold demanded by dealers in Zurich is

- A) 10,000/3.
- B) 5,000.
- C) 6,000.
- D) 10,000.
- E) none of the above

Answer: C

Diff: 3

Section: 4.3

40) The demand curves for gold in New York and Zurich can both be represented by a line with negative slope, -b. When the price is zero the demand for gold is x ounces higher in New York than in Zurich. At the current price of gold the price elasticity of demand for gold in New York and Zurich is -3 and -4 respectively. The value of x equals

- A) a quarter of the current demand for gold in New York
- B) a third of the current demand for gold in New York
- C) a half of the current demand for gold in New York
- D) three-quarters of the current demand for gold in New York
- E) none of the above

Answer: A

Diff: 3

Section: 4.3

41) Suppose your manufacturing firm is not a price-taking seller (i.e., has some control over your product price) and sells machinery to U.S. (domestic) buyers as well as foreign buyers. The domestic demand for your product is inelastic but the foreign demand is elastic, and the machinery is bulky so that the high transport costs prevent resale among the buyers. You could charge both groups of buyers the same price for the machinery, but you know that you could increase total sales revenue by charging the domestic buyers a ________ price and charging the foreign customers a ________ price.

- A) higher, higher
- B) higher, lower
- C) lower, higher
- D) lower, lower

Answer: B

Diff: 2

Section: 4.3

42) Many governments around the world attempt to improve the incomes of commodity producers by taking steps to increase the commodity price in the domestic market. Although this may reduce quantity demanded for the product, the action may be effective because:

- A) commodity supply tends to be inelastic, so quantity does not decline by much.
- B) commodity supply tends to be elastic, so producer income increases as a result of the higher prices and quantities.
- C) commodity demand tends to be inelastic, so higher prices generate higher sales revenue.
- D) commodity supply tends to be elastic, so producer income increases as a result of the higher prices and quantities.

Answer: C

Diff: 2

Section: 4.3

43) Suppose the aggregate demand for housing in the U.S. includes a substantial speculative component. What happens of the expectations of speculators change, and they believe housing prices will not increase in the future?

- A) The aggregate demand curve shifts leftward, and the equilibrium market price declines.
- B) The aggregate demand curve shifts leftward, and the equilibrium market price increases.
- C) The speculative demand curve shifts leftward, but the aggregate demand curve is unchanged.
- D) There is no change in the current demand for housing because speculators expectations are based on future events.

Answer: A

Diff: 1

Section: 4.3

44) Recent research estimates that the short-run price elasticity of demand for gasoline in the U.S. is -0.3, and the long-run price elasticity of demand is -1.4. What happens if the govenment increases the federal gasoline tax?

- A) Consumer expenditures on gasoline increase over the short run and long run
- B) Consumer expenditures on gasoline decline over the short run and increase over the long run
- C) Consumer expenditures on gasoline increase over the short run and decline over the long run
- D) Consumer expenditures on gasoline decrease over the short run and long run

Answer: C

Diff: 2

Section: 4.3

45) Joes Pig Palace sells barbecue plates for $4.50 each, and serves an average of 525 customers per week. During a recent promotion, Joe cut his price to $3.50 and observed an increase in sales to 600 plates per week.

- Calculate Joes arc price elasticity of demand.
- Joe is considering permanently lowering his price to $4.00 to increase revenue. How many plates should Joe expect to sell at the new price? Does the move make sense in the light of Joes desire to increase revenue?

Answer:

*a.*

* *E =

E =

E =

E = = -0.533

*b***.**

Since 4.00 is within this arc, -0.533 can be regarded as the relevant elasticity. We will use $4.50 and 525 as the beginning price and quantity

-0.533 =

-0.533 =

-0.533 = [Q2- 525] =

-0.533 = [Q2 + 525] = -17 Q2 + 8925

-279.83 0.533 Q2 = -17 Q2 + 8925

16.47 Q2 = 9204.83

Q2 = 558.88

Joes move doesnt make sense since demand is inelastic. With inelastic demand, price and total expenditures move in the same direction. As he lowers price, total expenditures will also fall.

To verify:

Before Cut total expenditures = $4.50 525 = $2,362.50

After Cut total expenditures = $4.00 559 = $2,236.00

Diff: 2

Section: 4.3

46) Harding Enterprises has developed a new product called the Gillooly shillelagh. The market demand for this product is given as follows:

Q = 240 4P

- If the shillelagh is priced at $40, what is the point price elasticity of demand? Is demand elastic or inelastic?
- If the shillelagh price is increased slightly from $40, what will happen to the total expenditure on the Gillooly shillelagh?

Answer:

*a.*

The price elasticity of demand equals (P/Q)(Q/P). If P equals $40, Q equals 80.

(Q/P) is constant along a linear demand curve. In this case it equals -4. Therefore, the price elasticity of demand equals (40/80)(-4) = -2 and demand is elastic.

*b.*

An increase in the price of a good with elastic demand will result in a decrease in the total expenditure on the good.

Diff: 2

Section: 4.3

47) Answer both parts of the following question.

- The San Francisco Chronicle reported that the toll on the Golden Gate Bridge was raised from $2 to $3. Following the toll increase, traffic fell by 5 percent. Based on this information, calculate the point price elasticity of demand. Is demand elastic or inelastic? Explain.
- Stephen Leonoudakis, chairman of the bridges finance auditing committee, warned that the toll increase could cause toll revenues to decrease by $2.8 million per year. Is this statement consistent with economic theory? Explain.

Answer:

Increasing the toll on the bridge form $2 to $3 is a 50 percent increase. Traffic is expected to decrease by 5 percent as a result of the toll increase. Therefore, the point price elasticity of demand is -5/50 or -0.1. Demand is inelastic. * *

* *

Stephen Leonoudakis statement is not consistent with economic theory. When demand is inelastic, an increase in price will increase total expenditures on a good (the total expenditure on the good is the total revenue of the firm). Since demand is inelastic here, toll revenues will increase rather than decrease.

Diff: 3

Section:

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