Economics 481-A1

Term Exam 1

S Landon 6 October 2003

You have 50 minutes to do this exam. There is no choice of questions. The number in brackets
next to each question indicates the maximum number of marks that can be earned on that
question. There are 100 marks in total. This is a closed book exam. No notes may be
consulted during the exam. This exam has two pages. Allocate your time carefully. You do
not need to do the questions in order.

No calculators or other electronic devices may be used during the exam.





(10) 1. If all goods are desirable, a diminishing marginal rate of substitution implies that the
marginal utility of each good is also diminishing. True, false or uncertain? Explain.
Your mark will depend entirely on your explanation.





2. Suppose an individual has the utility function:

U(x,y) = xg(y), 0<x, 0<y,

where x and y are the quantities consumed by the consumer of two goods. The person
has an income of M and faces per unit prices for x and y of P
x
and P
y
, respectively.

(10) a) What restrictions, if any, would the standard axioms of consumer preference
impose on the derivatives of the function g(y)? Justify your answer.

(15) b) Find the impact of a fall in the price of x on the demand for y.

(15) c) Suppose that the price of x falls. In a standard budget constraint indifference
curve diagram, illustrate the point or segment of the new budget constraint on
which the new optimal choice must lie. Explain your reasoning.





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3. Suppose an individual has the utility function:

U(x,y) = x + y

, 0<<1,

where x and y are the quantities consumed by the consumer of two goods and is an
exogenous parameter. The person has an income of M and faces per unit prices for x and
y of P
x
and P
y
, respectively.

(10) a) Find the demand functions for x and y.

(10) b) The property of adding up implies a relationship between the partial derivatives
of the two demand functions with respect to income. Derive this relationship for
the case of two general demand functions and then show that it holds for the
explicit demand functions derived in (a).

(10) c) Illustrate the Engel curve for x and explain as intuitively as possible whether the
share of income spent on x rises or falls with income.





(10) 4. The demand curve for an inferior good has a negative slope in the standard price-
quantity diagram. True, false or uncertain? Explain using words and a diagram. Your
mark will depend entirely on your explanation.





(10) 5. Suppose the government subsidizes purchases of a good by providing consumers with a
subsidy equal to a given amount s per unit of the good purchased. Show
diagrammatically how to measure the amount paid by the government to a consumer
under this subsidy. Clearly explain the logic of your diagram in words.





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