Explain the following.

1. In microeconomics the term utility references the:

i. relative scarcity of a good or service

ii. usefulness of a good or service

iii. satisfaction derived from consumption of a good or service

iv. slope of a consumers demand curve for a good or service

i

ii

iii

iv

ii and iii

iii and iv

Question 22 pts

The consumer choice models describes how an individual allocate his/her income over goods and services in order to maximize utility. One component of the consumer choice model is the individuals utility function. From the utility function alone, which of the following can be determined?

i. the utility maximizing bundle of goods and services a consumer will choose to purchase

ii. the utility derived from all bundles of goods and services

iii. the bundles of goods and services that yield the same level of utility

i

ii

iii

i and ii

ii and iii

i, ii, and iii

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Question 32 pts

Punk-rocker Pete is feeling insecure about his long-term relationship with economist Elaine. At the conclusion of a recent date, he tells Elaine, "I feel that I derive much more utility from this relationship than you." Elaine tells him that his claim is ridiculous because:

Elaine knows she has spent more income on Pete than Pete has spent on her over the course of their relationship

Elaine knows Pete has spent more income on her than she has spent on him over the course of their relationship

Elaine knows that utility is subjective and therefore it is not meaningful to make inter-personal utility comparisons

Pete knows he has spent more income on Elaine than Elaine has spent on him over the course of their relationship

Pete knows Elaine has spent more income on him than he has spent on her over the course of their relationship

both Elaine and Pete know they have spent the same amount of income on each other over the course of their relationship

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Question 42 pts

Marginal utility is the:

total utility from consuming a bundle of goods divided by the quantity of units consumed

change in total utility from consuming each additional unit of a good

change in total utility realized by consuming each additional unit of a good divided by the price of the good

sensitivity of consumer purchases of a good to changes in its price

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Question 52 pts

Which of the following is statements is correct?

there is no relationship between marginal utility and total utility

if marginal utility is diminishing but positive as consumption increases, then total utility will increase

total utility is equal to the change in marginal utility from consuming each additional unit of a good

if marginal utility is diminishing as consumption increases, total utility will also be diminishing

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Question 62 pts

The law of diminishing marginal utility states that:

the demand for a good will rise as price is lowered, holding all other factors constant

the quantity of a good demanded will rise as price is lowered, holding all other factors constant

as more and more units of a good are consumed, utility will decline beyond a point

in order to maximize utility, consumers will allocate their income such that marginal utility per dollar is equal across the goods purchased

none of the above options are correct

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Question 72 pts

Pete likes pie. If he consumes 1 piece of pie, he obtains 8 units of utility, if he consumes 2 pieces he obtains 12 units of utility, and if he consumes 3 pieces he obtains 15 units of utility. It follows that:

total utility is increasing at an increasing rate and marginal utility is increasing

total utility is increasing at an increasing rate and marginal utility is decreasing

total utility is increasing at an increasing rate and marginal utility is constant

total utility is increasing at a decreasing rate and marginal utility is increasing

total utility is increasing at a decreasing rate and marginal utility is decreasing

total utility is increasing at a decreasing rate and marginal utility is constant

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Question 82 pts

Suppose an individuals preferences are described by the Cobb-Douglass utility function U = X0.5Y0.5and consider the following three combinations (or bundles) of X and Y: Bundle A (3,4); Bundle B (6,1); Bundle C (2,5). Given the individuals preferences, the bundles ranked from least-preferred to most-preferred are:

Bundle A, Bundle B, Bundle C

Bundle A, Bundle C, Bundle B

Bundle B, Bundle A, Bundle C

Bundle B, Bundle C, Bundle A

Bundle C, Bundle A, Bundle B

Bundle C, Bundle B, Bundle A

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Question 92 pts

Suppose a consumers utility function is U = X0.5Y0.5. It follows that the indifference function associated with the bundle X = 8 and Y = 8 or (8, 8) is:

Y = 2/X

Y = 4/X

Y = 8/X

Y = 16/X

Y = 32/X

Y = 64/X

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Question 102 pts

If an indifference curve relating X and Y slopes downward, then it may be concluded that:

i. both X and Y are bads

ii. both X and Y are goods

iii. X is a good and Y is a bad or X is a bad and Y is a good

i

ii

iii

i or ii

ii or iii

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Question 112 pts

Consider an individual whose preferences are described by the utility function is U = X0.5Y0.5. If she consumes 2 units of X and 6 units of Y, then some level of utility will be experienced. If the individual instead consumes 4 units of X, how much of good Y must she consume in order to attain the level of utility associated with 2 units of X and 6 units of Y?

Y = 1

Y = 2

Y = 3

Y = 4

Y = 5

Y = 6

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Question 122 pts

Any bundle of goods located outside (versus inside) of a consumers budget constraint:

i. will yield more utility than any bundle located inside the budget constraint

ii. will yield more utility than any bundle located on the budget constraint

iii. implies the consumer is not spending all of his or her income

iv. is unobtainable, given the consumer's income

i

ii

iii

iv

i and iii

i and iv

ii and iii

ii and iv

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Question 132 pts

If a consumers income is $300, the price of good X is PX = $6, and the price of good Y is PY = $3, then the algebraic expression for the consumers budget constraint is:

Y = 50 - 0.5X

Y = 100 - 0.5X

Y = 300 - 0.5X

Y = 50 - 2X

Y = 100 - 2X

Y = 300 - 2X

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Question 142 pts

Suppose a consumer has an income of $15 that is spent on two goods: X and Y. The price of good X is $3.00 and the price of good Y is $1.00. Which of the following combinations (or bundles) of X and Y lie on the individuals budget constraint?

4X and 4Y

5X and 4Y

3X and 6Y

3X and 8Y

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Question 152 pts

If the consumer is a utility maximizer in allocating income over goods and services, then income will be allocated such that:

the marginal utilities of the goods and services purchased are equal

marginal utility per dollar is equal over the goods and services purchased

the prices of the goods of the goods and services purchased are equal

an equal proportion of income is spent on each of the goods and services purchased.

Part.b.

1) Figure 4.4 illustrates the demand for guitars. Assume guitars are an inferior good. An increase in income would bring about a movement from:

A) point B to point C.

B) point B to point A.

C) D1 to D0.

D) D1 to D2.

Part B.

9. (5 pts.) Show on the axes below how the presence of trade unions can impact the structural rate of unemployment in a country:

Wage

(3 pts.) Considering the process of fractional reserve banking, which reserve ratio would allow the smallest ultimate impact on the money supply, 17% or 6%? Why?

(4 pts.) An initial $3 billion increase in the money supply by the Federal Reserve resulted in an overall increase of $18 billion in the money supply.

What is the size of money multiplier?

What is the reserve ratio %?

Quantity of Labor

12.

(3 pts.) What is the method the Fed uses most frequently to change the money supply?

(4 pts.) Describe how this process alters the money supply:

13.

a. (3 pts.) Define each of the variables in the following equation: M V = P Y

b. (4 pts.) Applying the Quantity Equation and assuming that velocity is constant, what will be the rate of inflation if real GDP grows 4.5% in a given year and the money supply only increases 2.2%?

14. The figure below shows the market for loanable funds (in an open economy), net capital outflow and the market for foreign currency exchange.

(5 pts) Show how the graphs would be affected if a new tax increase on dividend income from stocks incentivizes people to save less.

(3 pts) How would this affect the real interest rate?

(3 pts) How would it affect the real exchange rate?

Real Interest Rate

Real Interest Rate

Quantity of Loanable Funds

Quantity

Real Exchange Rate

Quantity of Dollars

15. The figure below shows the market for loanable funds (in an open economy), net capital outflow and the market for foreign currency exchange.

(5 pts) Show how the graphs would be affected if China experienced an unexpectedly large crop of soybean one year and so decided to import less soybean from the United States (ie. US exports of soybean decreased significantly).

(3 pts) How would this affect the real interest rate?

(3 pts) How would it affect the real exchange rate?

Real Interest Rate

Real Interest Rate

Quantity of Loanable Funds

Quantity

Real Exchange Rate

Quantity of Dollars

16.

a. (3 pts.) Draw the Model of Aggregate Demand and Aggregate Supply you would use for

analyzing short and long-run fluctuations in the U.S. economy.

Price

(3 pts.) Use the graph to show the impact of the following event:

A large drop in the stock market causes businesses to become more pessimistic and reduce their level of investment.

(4 pts.) What happens to the price level in the short-run and long-run? (describe what happens in both cases)

(4 pts.) What happens to output in the short-run and long-run? (describe what happens in both cases)

Income, Output (Y)

e. (4 pts.) If the government wished to avoid the negative effects of a recession following the fall in investment, what could it do? How would this impact the AD-AS model? (just describe in words, there is no need to illustrate on the graph)

17. (4 pts.) If the initial impact on Aggregate Demand of a new airport security program amounts to $42 billion and the Marginal Propensity to Consume is 0.75, what would be the total impact on Aggregate Demand if a crowding out effect of $14 billion also occurs?

18.

a. (4 pts.) How does the Theory of Liquidity Preference explain the downward slope of the

AD curve?

b. (4 pts.) How does the Theory of Liquidity Preference explain why the AD curve shifts inward when the Fed decreases the money supply (M)?

19.

a. (3 pts.) Draw a graph showing the long-run and short-run Phillips curves (draw both

curves on the same axes below).

Inflation Rate

(3 pts.) Show a point on the short-run Phillips curve and indicate what would happen to that point in the short run if the Federal Government significantly increased its expenditures in an effort to stimulate the economy.

(4 pts.) If a newly invented mathematical algorithm was widely rolled out which can match unemployed people to their ideal job much more quickly, would this shift the long or short run Phillips curve? In which direction would the curve shift? (just describe, there is no need to show on the graph)

(3 pts.) How would the situation described in question 19c above affect the long-run aggregate supply curve?

Unemployment Rate

(4 pts.) If oil prices fell causing a positive supply shock, would this shift the long or short run Phillips curve? In which direction would the curve shift? (just describe, there is no need to show on the graph)

(4 pts.) In the AS-AD Model, would the situation described in question 19e above shift the SRAS, the LRAS or the AD curve? In which direct would the curve shift?

(3 pts.) Would the situation described in question 19e above cause 'stagflation'?

20. (5 pts.) Provide two examples of events that could shift the LRAS curve. Say in which direction the curve would shift, and also how the event would affect the long-run Phillips curve.

21. (5 pts.) What are three key lessons you will remember from taking ECON 204 Principles of Macroeconomics?

iii.

solve the following questions.

Question 1: Louis the retired Canadian lives on a fixed budget and consumes only two goods: toques (T) and maple syrup (M). Suppose Louis' monthly budget is 100 and the price of the two goods are (PT, PM) = (4,2). (a) Make a properly labeled diagram illustrating Louis' budget constraint with T on the hori- zontal axis and M on the vertical axis. Indicate the area corresponding to the set of bundles (M, T) that Louis can afford (b) What is the maximum T that Louis can afford? What about the maximum M? (c) What is the slope of the budget line, and what is the economic interpretation of it? (d) Suppose the Canadian government decides to ration maple syrup, limiting each person to a maximum of 40 units of maple syrup per month. Draw a new diagram showing Louis' new budget constraint and indicate the area corresponding to the set of bundles that Louis can afford now. Question 2: Annie and Marty are both single parents with full-time jobs. Consequently, both value child care services (5) and children's clothing (C) but may have different preferences for the two goods. The government decides it wants to make life easier for single parents and is considering providing single parents with monthly child care vouchers or, simply, providing single parents with a cash payment every month. Suppose Annie and Marty's incomes are both 400, the price per unit of child care is 10 per unit and the price per unit of clothing is 20. (a) Draw Annie's budget constraint assuming the government decides to offer a $100 voucher for child care. (b) Draw Marty's budget constraint assuming the government decides to offer a $100 cash payment to single parents. (c) Draw an indifference curve representing Annie's preferences that is consistent with Annie strictly preferring the cash payment to the voucher. (d) Draw an indifference curve representing Marty's preferences that is consistent with Marty being indifferent between the cash payment and the voucher. Question 3: After winning the lottery, Australian Artie decides to retire, stay home, and watch sports on television all day. Artie likes both Rugby, R, and Aussie Rules Football, F and views them as imperfect substitutes. In particular, Artie's preferences can be represented by the follow- ing utility function: U = R04Foe. Since Artie is rich, the only cost of watching F is the opportunity cost of not watching R: one hour of R necessarily means one hour less of F. In other words, even though Artie is rich, there is still a price on his time. 1-2 of 2(a) What is Artie's marginal rate of substitution between R and F, MRSay? Interpret it. (b) What is the price ratio, PR/PF? Interpret it. (c) Suppose Artie chooses some bundle, (R, F). If this bundle maximizes Artie's utility, what relationship must hold between R and F? (d) Define ME. What is the interpretation of this? If Artie is maximizing his utility, what must FR MUs be equal to? (e) Suppose there are 24 hours in a day. What bundle (R, F) will Artie consume? [Now you should find actual numbers.] Question 4: Picky Pete drags Indifferent lan out for coffee at an upscale Italian cafe which sells only espresso (E) and biscotti (B). Picky Pete simply must have one biscotti for every espresso consumed, whereas Indifferent lan views espresso and biscotti as perfect substitutes. One of their utility functions is given by U = min [E, B] and the other's by U = E + B. (a) Given the description, which utility function corresponds to which person? (b) Suppose the prices of the goods are (PEPs) = (2,1) and Pete has allocated $12 for the outing while lan brought only $4. Solve for each person's utility-maximizing bundle of espresso and biscotti. (c) Draw a fully labeled diagram illustrating Pete's budget constraint, his optimal bundle, and an indifference curve representative of his utility at his optimal bundle. Indicate how much utility Pete obtains. (d) Do the same for Ian. Question 5: Energetic Erin consumes a worrisome amount of caffeinated beverages, particularly soda (S) and coffee (C). A utility function representing her preferences is given by U = 450503. Erin's Income is 120 and the prices of the two drinks are given by (ps. pc) = (4,2). (a) Solve for Erin's utility maximizing bundle of beverages and calculate how much utility she obtains from it. (b) Suppose Erin moves to Berkeley where there is a soda tax and, consequently, the price of soda is 6. Solve for Erin's new utility maximizing bundle of beverages and calculate how much utility she obtains now. What is the "total effect" of the price change on Erin's consumption of soda? (c) Draw a diagram showing Erin's budget constraint before and after the move, and repre- sentative indifference curves of her choices before and after the move. (d) The total effect you found in part "b" can be broken down into a "substitution effect" and an "income effect". What is the sign of: (i) the total effect, (ii) the substitution effect, and (iii) the income effect? Explain why for (ii) and (uil). 1-2 of 2