EEP1/Econ3
Professor: Peter Berck
GSIs: Lilia Chaidez and Qu Tang
Fall 2012
Midterm I
1. Give a short definition of:
a. Externality (1 point)
b. Pareto preferred (1 point)
c. Normal good (1 point)
d. Open access (1 point)
e. Indifference curve (1 point)
2. a. Draw a diagram with two budget constraints that differ only in the price of the
good on the horizontal axis. Call this good on the horizontal axis bread. Label
your axes. You may assume that the price of the good on the vertical axis (wine)
is one. Now draw two indifference curves that allow you to find the consumer’s
chosen bundles for each of the two prices. Mark these bundles. (3 points)
b. Draw one more line on your diagram and use it to carefully explain that is the
compensating variation for the price change described above. (2 points)
3. Assume that the inverse demand curve for a product slopes down, but is not
vertical
a. Now draw an inverse supply curve and use it to explain the case where a
specific tax would be wholly incident upon the producer. (1 point)
b. Explain the role of any curves you draw in addition to your inverse supply
and inverse demand curves. Also, show on your graph the price paid by
consumers and the price received by producers.(2 points)
c. Now draw a second diagram that shows the case where a specific tax
would be wholly incident upon the consumer. Though you must label
your diagram, you need not explain anything. (2 points)
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4. Six people with identical tastes go to dinner together and agree to evenly split the
bill for dinner. Each person prefers the hamburger dinner for $6 to the steak
dinner for $10. However, all six people choose the steak dinner.
a. Explain how this choice is individually rational (2 points).
b. If one of these people went to dinner alone and had a choice between the
hamburger for $6 and the steak for $6.50, can you tell which the diner
would choose? What about steak for $7.50? (2 points)
c. Give another example where the wrong choice is made because people
share the consequences of their choice, rather than bear all the costs
individually. (1 point)
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