ECON 100 Tutorial: Week 4
www.lancaster.ac.uk/postgrad/alia10/
a.ali11@lancaster.ac.uk
office hours: 3:45PM to 4:45PM tuesday LUMS C85
Outline for this week’s tutorial
Past exam question ( from last week) – 5 min.
Question 1 – 2 min.
Question 2 – 3 min.
Question 4 – 5 min.
Question 5 – 10 min.
Question 7 – 20 min.
Solutions for Q6 and Q8 are in the slides (and on
Moodle) – please review them and email me or come
to office hours if you have questions, but we will not
be going over them in tutorial.
Past exam question from last week
From Week 3 tutorial (Question 6), we learned the following
equations:
The Incidence of a tax (or change in price with respect to a
change in tax):
𝑑𝑝
= 𝜀 𝑆 /(𝜀 𝑆 − 𝜀 𝐷 )
𝑑𝑡
Price Elasticity of Supply and Price Elasticity of Demand (this is
the point elasticity method, which involves taking the
derivative of the demand or supply curve):
𝑃
𝑆
𝜀 = ∗ (𝑑𝑆
𝑄
𝑃
𝐷
𝜀 = ∗ (𝑑𝐷
𝑄
𝑑𝑝)
𝑑𝑝)
Suppose D=120-4P. Find the price
elasticity at a price of 10 and at a price
of 20. Use the standard mathematical
method, not the midpoint method.
a)
b)
c)
d)
-0.2, -2, respectively
-0.5, -2, respectively
-0.5, -4, respectively
Not possible to say without knowing what
the corresponding level of demand is.
An Inferior Good:
a)
b)
c)
d)
Is a Giffen good
Has a positive income elasticity of demand
Has a negative income elasticity of demand
Has an upward sloping demand function
Suppose a demand curve is written
D=60-3P. Find the intercept and slope
of the corresponding inverse demand
curve.
a)
b)
c)
d)
Slope of -20, intercept of 3
Slope of -1/3, intercept of 20
Slope of -3, intercept of 20
Slope of 1/3, intercept of 60
Suppose D=200-2P and S=20+4P.
What is the equilibrium price and
quantity?
a)
b)
c)
d)
P*=20, Q*=100
P*=30, Q*=140
P*=50, Q*=220
P*=40, Q*=180
Question 1
Assuming an indifference curve which is convex to the
origin, what can this tell us about a consumer’s marginal
rate of substitution between coffee and muffins?
Question 2
Explain why the consumer’s optimal choice occurs where the
marginal rate of substitution (MRS) is equal to the relative price
of the two goods.
The optimal choice is where one
indifference curve is touching the
budget constraint at exactly one
point (where the indifference
curve is tangent to the budget
constraint).
The MRS is the same thing as the
slope of the budget constraint.
If a line is tangent to another line,
their slopes are equal at the point
of tangency.
Question 4
Would the assumption that goods are perfect
substitutes be valid in a study of intertemporal
food purchases?
Food today
Perishable foods
in one time
period are not a
perfect
substitute for
food in another
time period.
Food tomorrow
Question 5(a)
Use a diagram to distinguish between the income and substitution effects of
a change in the price of muffins when the price of coffee stays constant.
Assume both goods are normal goods.
So, what are a substitution effect and an income effect?
First, we draw our original budget constraint, original indifference curve, and
the new budget constraint.
Next, we can find the substitution effect, the movement along the
indifference curve, to a point whose MRS is equal to the slope of the new
budget constraint.
Finally, we can find the income effect – which will move us to a new
indifference curve on the new budget constraint – this depends on whether
our good whose price changed is a normal, inferior or giffen good.
Question 5(b)
Suggest an example of an inferior good. Use a diagram to
distinguish between the income and substitution effects
of a change in the price of the inferior good.
Question (c)
Suggest an example of a Giffen good. Use a
diagram to distinguish between the income and
substitution effects if a change in the price of
the Giffen good.
Question 7(a)
Suppose the price of a magazine is £2,
the price of a book is £10, and the
consumer's income is £100.
Which point on the graph represents
the consumer's optimum: X, Y, or Z?
What are the optimal quantities of
books and magazines this individual
chooses to consume?
Answer: Point Z.
25 magazines and
5 books.
Question 7(b)
Suppose the price of books falls to £5.
What are the two optimum points on the
graph that represent the substitution effect
(in sequence)?
Answer: From point Z to point X.
What is the change in the
consumption of books due to
the substitution effect?
Answer: From 5 to 8 books.
Question 7(c)
Again, suppose the price of books falls to
£5. What are the two optimum points on
the graph that represent the income
effect (in sequence)?
Answer: From point X to point Y.
What is the change in the
consumption of books
due to the income effect?
From 8 to 6 books.
Question 7(c) ctd.
Is a book a normal good or an inferior
good for this consumer? Explain.
Books are inferior because an
increase in income decreases the
quantity demanded of books.
Question 7(d)
For this consumer, what is the total change in
the quantity of books purchased when the price
of books fell from £10 to £5?
Answer: The quantity demanded increased from
five books to six books.
Question 7(e)
Use the information in this problem to plot the
consumer's demand curve for books on a
diagram.
Next Week
• Tutorial 5 Worksheet
• Practice exam questions in tutorial.
• Access past exams here:
http://www.lancaster.ac.uk/sbs/registry/Exam
s/PastPapers/PastPapers.htm
– You will need to select a year, then select ECON
100 or ECON 101. You will be looking at
approximately the first 10 questions from each
year’s exam.