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«Massachusetts Institute of Technology Department of Economics 14.01 Principles of Microeconomics Final Exam Wednesday, October 10th, 2007 Last Name ...»

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Massachusetts Institute of Technology

Department of Economics

14.01 Principles of Microeconomics

Final Exam

Wednesday, October 10th, 2007

Last Name (Please print): ______________

First Name: __________________

MIT ID Number: __________________

Instructions. Please read carefully.

The exam has a total of 100 points. Answers should be as concise as possible.

This is a closed book exam. You are not allowed to use notes, equation sheets, books or any other aids. You are not allowed to use calculators. You must write your answers in the space provided between questions. DO NOT attach additional sheets of paper. This exam consists of (18) sheets (13 pages + 5 blank pages for scratch work).

0. Circle Your Section/Recitation (1 point):

Please circle the section or recitation which you are attending below. The marked exam will be returned to you in the section or recitation that you indicate. You will loose 1 point if you leave it unselected.

S01: MWF9 (Peter Schnabl) R01: F10 (Rongzhu Ke) S02: MWF10 (Chia-Hui Chen) R02: F11 (Rongzhu Ke) S03: MWF11 (Chia-Hui Chen) R03: F2 (Rongzhu Ke) S04: MWF1 (Monica Martinez-Bravo) R04: F12 (Marco Migueis) R05: F1 (Marco Migueis) R06: F2 (Marco Migueis)

DO NOT WRITE IN THE AREA BELOW:

Question 1 __/20 Question 2 __/10 Question 3 __/15 Question 4 __/25 Question 5 __/29 Question 0 __/1 Total __/100 Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

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1. True/False Questions (TOTAL: 20 points):

In this section, write whether each statement is True or False. Please fully explain your answer, using a diagram if appropriate. No credit will be given for an answer without an explanation.

(a) (5 points) A risk averse individual that has to decide between two different lotteries will always prefer a lottery with less risk.

False. A risk averse individuals dislike risk but not at “any price”. They will take into account the expected value of each lottery in their decisions.

(b) (5 points) Steven only consumes two goods: X and Y. If X is a Giffen good for Steven, then Y must be a normal good for Steven.

True. A Giffen good is an inferior good. Since Steven only consumes two goods, they cannot both be inferior goods. Therefore, Y is a normal good. (Need to point out explicitly that Giffen goods are a special kind of inferior goods, or the negative income effect of a Giffen good dominates the substitution effect. People who only say that the consumption of a Giffen good decreases with income without explanation lose partial points.)

–  –  –

–  –  –

False. The line that goes through the kinks of the indifference curves doesn’t need to have slope 1. Consider a consumer that likes to consume both goods in a ratio 2:1. In that case the first bundle is in another indifference curve with a lower level of utility associated.

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

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2. Short Answer Questions (TOTAL: 10 points):

(a) (4 points) Mary’s demand curve for food is Q = 10 − 2P. Her price elasticity of demand for food at price P* equals −. How much is P*?

–  –  –

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

Page 4 of 7

–  –  –

3. (15 points) Jane has utility function over her net income U (I ) = I (a) (2 points) What are Jane’s preferences towards risk? Is she risk averse, risk neutral or risk loving? [Explain briefly your answer]

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(c) (2 points) Paul also faces the same dilemma every single day. But he has a utility function U(I)=I. His daily income is also $100. What are Paul’s preferences towards risk? Is he risk averse, risk neutral or risk loving?

–  –  –

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

Page 5 of 7 4. (25 points) In Country Faraway, cigarettes are forbidden, so people trade cigarettes in a black market. The cigarette demand is QD = 12 − P, and the cigarette supply is Qs = 2P.

(a) (3 points) Find the equilibrium price and quantity in the black market.

–  –  –

(d) (8 points) Suppose that the government changes the policy and legalizes cigarette dealings. Now cigarettes are traded in an open market. However, for every unit of the cigarettes bought, the buyer has to pay tax T to the government. T is equal to the pre-tax price P. What are the demand and supply functions under this circumstance? What are the equilibrium (pre-tax) price and quantity? What is the after-tax price paid by buyers?

–  –  –

The quantities and the (after-tax) prices paid by buyers are the same in both cases.

Therefore, consumers feel indifferent. For the government, the policy in (b) requires extra expenditure on police and the policy in (d) brings tax revenue.

Therefore, the government prefers (d).

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

Page 6 of 7 5. (29 points) Eric receives utility from days spent traveling on vacation domestically (D) and days spent traveling in a foreign country (F) as given by the utility U(D, F) = DF.

The price of a day spent traveling domestically is $160 and in a foreign country $200.

Eric’s annual budget for traveling is $8,000.

(a) (5 points) Find Eric’s utility maximizing choice of days traveling domestically and in a foreign country. Find also his utility level from consuming that bundle.

–  –  –

(b) (6 points) Suppose that the price of domestic traveling increases to $250 per day.

Calling his budget for traveling x, (suppose by now that it is unknown) find the demand for D and F under the new prices as a function of x.

–  –  –

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

Page 7 of 7 (f) (5 points) Using your previous answers tell us what is the total change in quantity of D due to the price increase in PD that the consumer experiences and what part of that change is due to income or substitution effects. Give definitions of what income and substitution effects mean.

–  –  –

Cite as: William Wheaton, Chia-Hui Chen, Rongzhu Ke, Monica Martinez-Bravo, Marco Migueis, Peter Schnabl, and Hongliang Zhang, course materials for 14.01 Principles of Microeconomics, Fall 2007. MIT OpenCourseWare (http://ocw.mit.edu/), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].

MIT OpenCourseWare http://ocw.mit.edu

14.01SC Principles of Microeconomics Fall 2011 For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms.





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