EC 203.01
PS: CH 9
FALL 2006
1. Edgar consumes only apples and bananas. His endowment is 5 units of apples and 10
units of bananas. Both goods are normal goods for Edgar. At current prices, Edgar is a
net seller of apples. If the price of apples rises and the price of bananas stays the same,
his demand for apples must decrease. FALSE
2. Suppose a consumer is initially endowed with a positive amount of two goods, sells
some of one to get more of the other, and has no other sources of income. If the price of
one good falls, his new budget line is everywhere above his old budget line. FALSE
3. Chloe’s utility function is
, where C is dollars spent on goods
other than housecleaning, D is the number of hours per day that somebody spends
cleaning her house, H is the number of hours per day Chloe spends cleaning her house,
and J is the number of hours per day Chloe spends working at her job. All Chloe’s
income comes from her job. She can work as many hours a day as she wishes at a wage
of $7 an hour.
a. If she cannot hire anyone to do her housecleaning, how many hours will she spend on
the job and how many hours will she spend housecleaning?
b. If she can hire a housecleaner at $5 an hour, how many hours will she work on her job,
how many hours of housecleaning will she hire, and how many hours will she clean
house?
a. 6 hours and 1 hour.
b. 7 hours,
hours, and 0 hours.
4. Curtis’s utility function for goods and leisure is U(G, L) = G – (20 – L)(20 – L), where
G is consumption of goods and L is the number of hours of leisure per day. Goods cost $1
per unit.
a. If Curtis had an income from nonlabor sources of $25 per day and could work as much
as he chose to but would get zero wages, how much would he work?
b. Sketch Curtis’s indifference curves on a graph with leisure on the horizontal axis and
income on the vertical axis. If Curtis’s nonlabor income were $25 a day and he could
work as much as he wished for $10 an hour, how many hours a day would he choose to
work?
a. 4 hours a day.
b. 9 hours a day.
5. A farmer gets 20 eggs and 10 tomatoes every week from her chickens and her tomato
plants. She has no other source of income. She has convex, downward-sloping
indifference curves. The current market prices are $2 per egg and $3 per tomato. At these
prices she chooses the same bundle that she is endowed with (20 eggs and 10 tomatoes).
a. If relative prices change in any way whatsoever, she will certainly be no worse off and
may be better off than she was before the price change.
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b. An increase in the price of eggs (with the price of tomatoes remaining constant) will
decrease her utility.
c. An increase in the price of tomatoes (with the price of eggs remaining constant) will
make her worse off.
d. If both prices rise, she will be worse off, but if only one price rises, she might be made
better off or worse off, depending on her tastes.
e. Since she earns her income from tomatoes and eggs only, she treats eggs and e. Since
she earns her income from tomatoes and eggs only, she treats eggs and tomatoes as
perfect substitutes. A
6. Jack has a small garden where he raises eggplant and tomatoes. He consumes some of
these vegetables and sells some in the market. Eggplants and potatoes are perfect
complements for Jack, since the only recipes he knows use them together in a 1:1 ratio.
One week his garden yielded 30 kg of eggplant and 10 kg of tomatoes. At that time the
price of each vegetable was 5 YTL per kg.
a) What is the monetary value of Jack’s endowment of vegetables?
b) On a graph with tomatoes on the horizontal axis draw Jack’s budget line. Jack ends up
consuming ___ kg of eggplants and ____ kg of tomatoes. Draw the indifference curve
through the consumption bundle that Jack chooses and label this bundle A.
c) Suppose that before Jack makes any trades, the price of tomatoes rises to 15 YTL and
the price of eggplant stays at 5 YTL. What is the value of Jack’s endowment now
(____ YTL)? Draw his new budget line. He will now choose a consumption bundle
consisting of ____ tomatoes and ____ eggplants. Label this bundle C. Show all the
effects on the graph!
d) Suppose that Jack had sold his entire crop at the market for a total of 200 YTL,
intending to buy back some tomatoes and eggplant for his own consumption. Before he
had a chance to buy anything back, the price of tomatoes rose to 15 YTL while the price
of eggplant stayed at 5 YTL. Draw his budget line. Jack will now consume ____ kg of
tomatoes and ____ kg of eggplant. Label this bundle D. Show all the effects on the graph!
e) Assuming the price of tomatoes rose to 15 YTL from 5 YTL before Jack made any
transactions, the change in demand for tomatoes due to the substitution effect was ____.
The change in the demand for tomatoes due to the ordinary income effect was ____. The
change in the demand for tomatoes due to the endowment income effect was _____. The
total change in demand for tomatoes was ____. Show all the effects on the graph!
Compare this exercise with the one on page 171 of the textbook (Figure 9.7). Observe
that the labels are the same. Why is there a difference regarding the substitution effect?
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