1. When a gasoline tax is offset by an income-tax cut that makes a consumer s original choice just affordable, the price ratio _____ (increases/ decreases). In this case, there is no _____ effect, and gasoline consumption _____ because of the _____ effect.

2. Arrows up or down: A decrease in the price of the good shown on the horizontal axis _____ the slope of the budget line (the absolute value) _____ and the price ratio.

3. At every point on the demand curve, the marginal rate of substitution equals _____.

4. To show the substitution effect of a decrease in price, we _____ (increase/decrease) a consumer s nominal income so the consumer can just afford _____.

5. Suppose the gas tax increases and the income tax decreases to make a consumer s original bundle affordable. At the original bundle, the marginal rate of substitution _____ the price ratio, so the changes in taxes _____ the utility-maximizing quantity of gasoline.

6. Suppose Biff s parents adjust their monthly payment to offset any change in price, ensuring that the bundle Biff chose the previous month is just affordable. Suppose the price of movies changes. The change in the parental payment equals _____ time’s _____. If the price of movies decreases and the parents adjust the payment, Biff will buy _____ (more/fewer) movies because of the _____ effect.

7. Response to the Gas Tax. Petrov earns $10,000 in pretax income and initially pays $2,200 in income taxes, consumes 600 gallons of gasoline per year (at a price of $3 per gallon), and spends $6,000 on other goods (at a price of $1 per unit).

a. Draw a complete graph showing Petrov s initial (before the gas tax) budget line, indifference curve, and utility-maximizing quantities of gas and other goods (in $ spent). At his initial choice, the marginal rate of substitution is _____.

b. Suppose the government imposes a new gasoline tax of $2 per gallon, and assume that the gastax increases the price of gas to $5. To make his initial bundle of gasoline and other goods affordable after the $2 gas tax, Petrov s income tax must decrease by _____.

c. On your graph, draw a new budget line for a policy that combines the $2 gas tax with the change in income tax you computed for part b.

d. Use your graph to show whether the tax policy will increase, decrease, or not affect Petrov s gas consumption.

8. Shipping the Good Apples Out? Suppose apples come in two quality levels, low and high. At a store in the apple-growing region, the price of low-quality apples is $1 per pound and the price of high-quality apples is $4 per pound. Johnny lives in the apple growing region, and maximizes utility, spending his $25 income on five pounds of each type.

a. Use a complete consumer-choice graph to show Johnny s initial choice. Put high-quality apples on the horizontal axis and low-quality apples on the vertical axis.

b. Suppose Johnny moves to an area outside the apple-growing region, where his income is $45 (up from $25). Shipping the apples to his new area adds $2 to the price of a pound of apples, for both low quality and high-quality apples. Use a consumer choice graph to show his new budget line and his new utility-maximizing choice of low-quality and high-quality apples.

c. What does this exercise suggest about the mix of high-quality and low-quality apples in apple-growing areas compared to the high-low mix in other areas? Will the proportion of high-quality apples be higher or lower in the apple-growing region?