Question

Question 1: The substitution effect of a price decrease for a good with a normal indifference curve pattern is graphed by

a. drawing a new budget line tangent to the indifference curve attained at the new price.

b. drawing a new budget line tangent to the original indifference curve but at the slope of the new price of the good.

c. drawing a new budget line parallel to the initial budget line but tangent to the indifferent curve attained at the new price.

d. doing none of the above because the substitution effect cannot be graphed

Question 2: Elasticity values

a. establish proportion and therefore give perspective to an issue.

b. eliminate the need for constant specification of units of measure­ment.

c. can be calculated with numerous methods.

d. are described, in part, by all the above.

Question 3: The income elasticity of an inferior good is

a. negative because as people get richer they increase their purchases of the good by smaller and smaller amounts.

b. 1 because the increased income offsets the desire to consume less of the good because it is inferior.

c. greater than 1 because the richer you get, the less you consume of the good.

d. negative because higher income leads to a reduction in the amount consumed of the product.

Question 4: Which of the following goods are most likely to have a negative cross-price elasticity?

a. your micro text and this study guide

b. your micro text and your literature text

c. ice cream and candy in the snack shop

d. all the above

Question 5: If the quantity of movies you watch increases by one for each price drop of one dollar and you presently buy 5 at the current price of $5, which of the following is true?

a. Your current price elasticity of demand is -5

b. Your current price elasticity of demand is -1

c. If the price falls to $4 you will spend more on movies.

d. You will spend the same amount on movies no matter what happens to price.

Answer 1

(1) (b)

To find substitution effect, a budget line is drawn parallel to new budget line (so slope of this line is same as slope of new budget line), which is tangent to original indifference curve.

(2) (d)

Elasticity of Variable Y with respect to variable X = % Change in value of Y / % Change in value of X, which is unit-free.

(3) (d)

For an inferior good, increase (decrease) in income will decrease (increase) its demand, so income elasticity < 0.

(4) (a)

Micro-text and this study guide are used together, so they are complements. Cross-price elasticity between complement goods is negative.

(5) (b)

When P = 5, Q = 5

When P = 4, Q = 6

% change in Q = (6/5) - 1 = 1.2 - 1 = 0.2 = 20%

% change in P = (4/5) - 1 = 0.8 - 1 = - 0.2 = - 20%

Price elasticity of demand = % change in Q / % change in P = 20% / -20% = - 1