# Take home exam

**EXAM 1**

__Directions__

- Spend no more than 3 hours working on the exam.
- You may use your text, your class notes, and your homework as resources.
- You may NOT collaborate with other students, or use any other resources not listed above.
- You may ask me questions about the exam, which I may or may not answer.
- Turn in the exam no later than the beginning of class on Monday, February 11th.

Part I: Short Asnwer—Answer in 2-5 sentences; 5 points each

- Explain why indifference curves are negatively sloped (most indifference curves, anyway).
- What kind of behavior would a microeconomist consider truly “irrational”?
- Jack and Jill have been going to market every day for weeks, each with a bucket of apples and a bucket of oranges, and the market has been in equilibrium for some time. One Tuesday jack fell down and lost his oranges. What can we expect to happen to Jill's quantity of apples demanded? Why?
- Explain why indifference curves representing distinct levels of preferences cannot cross.
- How is an inferior good different from a Giffen good?
- You overhear a customer in a restaurant say "I' simply can't eat another bite." Draw her indifference map at this point and explain what it means.

Part II: Problems—10 points each; show all your work for full credit.

- A consumer spends her entire income on pizza and CDs. Write out the equation for the budget line in the following situations and graph it, labeling the intercepts and the slope.

- Monthly income is $1000, the price of pizza is $8 and the price of CDs is $10.
- Income is $500, and the prices are the same as above.
- Income is $500, the price if pizza is $8, and the price of CDs is $5

2. Vera is an impoverished student who only has $100 a month to spend on food. She has read that she can assure an adequate diet by eating only peanut butter and carrots in the fixed ratio of 2 pounds of peanut butter to one pound of carrots, so she decides to do so.

- If peanut butter costs $4 per pound and carrots cost $2 per pound, how much can she eat during the month?
- Suppose peanut butter costs rise to $5. because of a new government policy. By how much will Vera have to reduce her food purchases?
- How much in food stamp ad would the government have to give her to compensate for the effect of the new policy?
- Explain why Vera's preferences are of a very special type. What would they look like graphically?

3. Mr. Wright, a clothing salesman, is forced by his employer to spend at least $100 of his weekly income of $500 on clothing. Show graphically that his utility is lower than if he could freely allocate his income between clothing and all other goods.

4. The market demand for cashmere socks is given by:

Q = 1,000 + 0.5I - 400P = 200P'

where

Q = annual demand in number of pairs

I = average income in dollars per year

P = price of one pair of cashmere socks

P/ = Price of one pair of wool socks

Given that I = $20,000, P = $10, and P' = $5, determine the price elasticity of demand, the income elasticity of demand, and the cross price elasticity of demand at this point.

Part II: Longer Answers—Answer in a paragraph or so; 10 points each

- Explain in words why the optimal choice for consumption occurs where MRS= the slope of the budget line. Be sure to explain the information that is included in both the indifference curve and the budget line.
- Explain in words and in graphs the substitution and income effects of a change in price on demand. Why do we care about breaking down the effect this way?
- Two economists propose to use utility theory to understand consumer behavior in "the real world." The first economist, Dr. A., proposes to interview consumers in the grocery store parking lot before they shop to ask them about their preferences. The second economist, Dr. B. proposes to interview the shoppers as they leave the grocery store, and ask them about their purchases. Which method would you recommend they pursue? Explain your reasoning.