Dr. Barry Haworth
University of Louisville
Department of Economics
Economics 301
Summer 2000

### Exam #1

Your answers will be assessed in terms of both accuracy and completeness, but also upon your ability to clearly demonstrate that you understand the relevant concepts involved in each question. When math is needed to answer a question, you must show all relevant work to get full credit.

Section 1: Answer all three of the following three questions
1. On a new FOX game show, both Bill and Ted have each accumulated \$25,000 in winnings. Suppose the show's host offers each of these men the option of taking a \$25,000 check or of getting a \$25,000 Fiji vacation. Use indifference curve analysis to explain why Bill prefers the cash to the vacation, even though Ted is indifferent between the two.

2. Frik consumes differing quantities of nachos (N) and good X (X), while Frak consumes differing quantities of nachos and good Y (Y). Both individuals are trying to determine whether or not they're at an equilibrium.

Use indifference curve analysis to discuss each person, in turn, stating whether that person is at an equilibrium and (if necessary) what that person should do to arrive at the equilibrium.

a. Frik is currently consuming where the marginal utility associated with consuming nachos is twice as large (in absolute value) as the marginal utility associated with consuming good X, even though the price of nachos is only half the price of good X.

b. Frak's marginal rate of substitution for nachos and good Y (MRSN,Y) is always equal to a value of 4 (in absolute value), even though the nachos are only 1/4 of the price of good Y.

3. For off-campus students, the University of Louisville sells two types of parking permit, green and blue. Blue permits are more expensive but they allow you to park somewhat closer to campus than the green permits. The university will only sell you one parking permit per year, but assume that the price of each permit is constant over time.

a. Use this information along with indifference curve analysis to describe your decision to purchase a parking permit.

b. Use this information along with indifference curve analysis to describe how your decision is affected by the fact that your income steadily increases during your academic career.

Section 2: Answer two of the following three questions
1. The utility (U) associated with consuming differing quantities of cheese slices (C) and quantities of good X (X) is given by the following equation: U = (CX)0.5

If we assume cheese slices are the good on the horizontal axis, then the marginal rate of substitution for cheese slices and good X (MRSC,X) can be expressed as -X/C.

The price of cheese slices (PC) is \$1, while good X has a price (PX) of \$10. Your income is \$500 per month.

If the price of cheese slices increases to \$2, then show whether cheese slices are a normal good, an inferior good, or a Giffen good.

2. Suppose Louisville city and county governments are considering two tax plans to finance the building of a professional basketball arena. Those plans are:

Plan 1: a 20¢ tax on every gallon of gasoline sold within Jefferson County
Plan 2: a \$100 annual tax on every person living in Jefferson County (regardless of age or income)

The government learns that both plans would raise the same amount of annual tax revenue. From the perspective of how these plans would each affect utility, discuss whether one plan is better than the other.

3. Briefly address each of the following.

a. Good A has a very large, and positive, cross-price elasticity with respect to several other goods. Suddenly, the price of one of these other goods decreases. Describe what will happen in the demand curve graph corresponding with this market and why.

b. What is the relationship between income elasticity and Engel's Law?

c. You sell good X in one market and good Y in another market. You notice that when good X's price increases by 10%, the quantity demanded for good X decreases by 20%. If Y's price rises by 20%, then Y's quantity demanded also falls by 20%. Assuming that the demands for these two goods are linear, is it possible to increase your sales revenue by changing the price of either (or both) good?