ECON 281
Practice Problems for January 26 and 29
NOTE: The tutor will work through these problems in sessions on January 26 (10:00 –
10:50) and January 29 (1:00 – 1:50) in room Tory B 109. Answers will not be posted. These
sessions are not mandatory, but are recommended for students who would like extra
practice and to see additional problems worked through.
1. Suppose that I can spend my monthly allowance on either comic books or gum. For each
of the following, sketch on a graph, indifference curves corresponding to the preferences
described:
(a) Suppose a basket contains C comic books and G packs of gum. I am indifferent
between consuming C comics and G packs of gum, and consuming C+1 comic books
and G-2 packs of gum, regardless of what C and G are.
(b) Suppose a basket contains C comic books and G packs of gum. My preferences are
represented by U(C,G) = max{C, G} (i.e. my utility is the bigger of the two
numbers).
(c) I always prefer market baskets containing more comics to baskets containing fewer
comics, regardless of how much gum they contain. For example, I always prefer
baskets with 3 comics to baskets with 2 comics, no matter how many packs of gum
are in the baskets. It two baskets contain the same number of comic books, I prefer
the basket with the most packs of gum.
2. Jane has $2000 every month to spend on movies and books. Suppose the price of books
is $10 per unit. The price of movies is $20 per movie for the first 50 movies, $10 for the
next 50 movies, and $5 for every movie after.
a. If Jane spends all her income on movies, how many movies will she purchase? If
she spends all her income on books, how many books will she purchase?
b. Draw Jane’s budget line. What is the slope of this budget line?
3. Suppose that the market demand curve for a good is given by Qd = 100 – P. The market supply
curve is given by Qs = 10 + P.
(a) Sketch the demand and supply curves on a graph.
(b) Solve for the competitive market equilibrium price and quantity, and illustrate this on your
graph.
(c) Suppose now that the firms in the market collude, and increase the price to 55. Show on your
graph how consumer surplus falls. Compute the change in consumer surplus resulting from this
price increase.
4. Suppose that the demand curve for bagels is given by the equation Q=100 – 2P, where P is the
price measured in dollars.
a. Draw the demand curve
b. Compute the price elasticity of demand when
i. Price is $10
ii. Price is $40
c. For each price level considered in (a), is demand elastic or inelastic?
d. At each price level considered in (a), would a small increase in the price increase
or decrease the total expenditure by consumers on bagels? Explain your answer.