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# UNIVERSITY OF CALIFORNIA, RIVERSIDE

DEPARTMENT OF ECONOMICS
Spring 2011
Maithili Ramachandran

## Instructions you will read on the cover page of the test 1

1. Write your full name and student ID in the space indicated below.
2. Circle the name of your Teaching Assistant. Your discussion section # is not required.
3. This exam is for 50 points. It contains 7 pages and 4 questions.
4. You will have 50 minutes from 3:10 to 4:00pm to complete the test.
5. Cheating gets you a zero and an F.
6. Present your work with care: draw neat and fully-labelled diagrams, show your
computation and proofs in full and be legible in your writing.

## Teaching Assistant: Anca Sirbu Jacob Kevari

Sarah Daway Sheetal Bharat

## Question Question Question Question Total

1 2 3 4

1
Practise with instruction #6 in mind and it will serve you well on the test.
1. Suppose you had the utility function u(x1, x2, x3, x4) = x10.4 x20.2 x30.2 x40.2 and you had
\$100 to spend on these four goods. How much should you spend on good 1 to maximise

2. Suppose you had the utility function u(x1, x2) = x1-1 x2. Draw the indifference curves
corresponding to utility levels of 10, 20 and 30. What does the shape of these indifference
curves tell you about the nature of the two goods?

3. Gwyneth is a travelling enthusiast. She saves up every year so she can take a vacation
abroad for at least a week. This year she is going to Scandinavia for a month so she plans
to buy new boots and gloves. The boots she likes cost \$149 a pair; the gloves are \$13
each.
(a) If she likes to have twice as many pairs of gloves as boots, how many of each will she
buy with a budget of \$350?
(b) What kind of preferences does Gwyneth seem to have for the two goods she is

4. Denholm is the head of the largest IT company in the UK, a fact he prides himself on
greatly. He is not very involved with the business these days though, preferring to occupy
himself with selecting striped ties and beer mugs. Denholm’s preferences for ties (T) and
mugs (M) follows the utility function u(T, M) = 17T + 29M. The price of any tie is \$17
and a mug costs \$29.
(a) Denholm spent \$1972 on ties or mugs in the last year. If he had been maximising his
utility, how many striped ties and beer mugs would he have bought?
(b) The price of mugs has halved this year and Denholm plans to spend only \$493 on
mugs or ties. What is his optimal bundle now?
(c) What kind of preferences does Denholm exhibit for ties and mugs?

5. Robin sets aside \$1000 each month for food (x1) and gasoline (x2). Gas is \$2.50 a gallon
and food is \$19 per unit. Robin’s demand for gasoline is given by x2 = 0.05m/p2.
(a) Compute Robin’s consumption of food and gas.
(b) If gasoline is subsidized at the rate of 50 cents per gallon, how does Robin adjust her
consumption of food and gas?
(c) Did Robin’s expenditure on food change as a result of the gas subsidy? Does it
change if instead of a subsidy, a tax of \$1.50 per gallon was placed on gasoline?
(d) Bonus: What can you infer about Robin’s demand for food? (i.e. do you think it is
influenced by the price of gasoline?)

## 6. Show why indifference curves cannot cross.

7. Fred has a monthly income of \$1800. Each month he orders small pizzas at the price of
\$11 each, books from Amazon.com at the price of \$32.56 each and DVDs from
Blockbuster at \$0.99.
Suppose his consumption of pizzas, books and DVDs is lumped into one composite good
called X1. Let the price of the composite good, p1 simply be the sum of the three unit
prices above.
His city sets the water rate at \$3 per 750 gallons. Denote Fred’s water consumption in
gallons by x2.
Fred’s demand for the composite good is given by x1 = 0.99m/p1.

(a) In a given month, how many gallons of water does Fred use? How many units of the
composite good does he consume?
(b) His city council decides to tax water consumption at the flat rate of \$2 for every 750
gallons. How does this change Fred’s water use?
(c) If an income tax was levied on Fred such that the city collects the same tax revenue
from Fred as the flat rate, what would it be?
(d) If Fred paid this amount as income tax, what is his optimal bundle now?
(e) Will Fred vote for the city council to levy the quantity tax or the income tax? Explain.

## (a) u(x1, x2) = min.{x1, x2}

(b) u(x1, x2) = 3x1 + ln(x2)
(c) u(x1, x2) = 5x1 x2
(d) u(x1, x2) = x1 + 4x2

9. In the following cases, identify the utility functions that violate the assumption of
monotonicity, convexity or both:

## (a) u(x1, x2) = max.{2x1, x2}

(b) u(x1, x2) = (x1 + x2)2
(c) u(x1, x2) = x1 + ln(x2)