Prace 1

Econ 73-250A-F
Spring 2001
Prof. Daniele Coen-Pirani
Practice Exam #1
As indicated on the course syllabus, this practice exam will be discussed during your recitation
section on Friday, February 16. In the Þrst midterm exam of Monday, February 19 you should
expect exercises comparable in their difficulty to the ones in this practice exam. Notice also that
you won’t be allowed to use any books or notes during the exam. The points associated to each
question in this practice exam are indicated in brackets. The total number of points is 100.
Exercise #1. Andy consumes two goods: food (measured in dollars) and other things (also
measured in dollars). Let x1 be the amount that Andy spends on food in a given month and let
x2 be the amount that Andy spends on other things in a given month. Andy’s preferences over
consumption bundles (x1 ,x2 ) are summarized by the utility function:
u (x1 ,x2 ) = x1 x2 .
Andy’s monthly income is $400.

(a) [10 pts.] What is Andy’s optimal consumption bundle? Show your work. Illustrate your
answer with a neat and clear diagram showing Andy’s budget line and indifference curves. Label
the points at which the budget line intersects the axes and identify the optimal bundle.
(b) [10 pts.] Suppose now that the government implements a subsidy program for food. Specif-
ically, for each dollar that Andy spends on food, the government will give Andy $0.50 in cash, with
the restriction that the total amount of cash that Andy receives from the government cannot exceed
$100. In a neat and clear diagram, graph Andy’s budget line. Label the points at which the budget
line intersects the axes and determine the coordinates of the kink point.
Exercise #2. Barb’s preferences over consumption bundles (x,y) are summarized by the
following utility function:
u (x1 ,x2 ) = 16x − 2x2 + 4y,
where x is the amount of good x that Barb consumes and y is the amount of good y that Barb
consumes. Let px and py be the prices of goods x and y, respectively. Let m be Barb’s income.
Barb’s goal is to maximize her utility subject to her budget constraint.
(a) [10 pts.] Find an algebraic expression for Barb’s marginal rate of substitution between
goods x and y. Show your work. In addition, give a coincise explanation of the meaning of the
marginal rate of substitution.
(b) [10 pts.] Suppose that px = py = 2 and m = 24. Use your answer from part (a) to
determine Barb’s optimal consumption bundle. Show your work.
(c) [10 pts.] Suppose now that px increases to 6, while py and m remain the same. What are
Barb’s optinal choices for x and y in this case? Is Barb better or worse off than she was in part
(b)? Explain.
1
(d) [10 pts.] How much extra income must Barb be given in order to compensate her for the
increase in the price of good x in part (c)? Explain.
Exercise #3. Consider the following statements and say whether they are true or false and
why. To get credit you should provide a clear justiÞcation for your answers.
(a) [4 pts.] If two goods are perfect complements and the price of one of them increases, the
quantity demanded of both goods decreases.
(b) [4 pts.] A non-transitive preference relation º can be represented by some utility function.
(c) [4 pts.] Consider two goods x and y. If preferences are strictly convex, the absolute value
of the marginal rate of substitution between x and y is decreasing along an indifference curve as x
increases.
(d) [4 pts.] The following Cobb-Douglas utility functions represent two different preference
relations:
u1 (x,y) = 0.3 log(x) + 0.6 log(y)

u2 (x,y) = 0.6 log(x) + 1.2 log(y).
(e) [4 pts.] If a consumer is making an optimal choice between two goods x and y, then,
independently of his preferences, the following condition must always hold:
px
− = MRS (x,y) .
py
(f) [4 pts.] If the following condition holds

px
− = MRS (x,y)
py
then a consumer must be making the optimal choice between x and y, independently of his
preferences.
(g) [4 pts.] A cigar is a luxury good for a consumer that has Cobb-Douglas preferences over
cigars and food.
(h) [4 pts.] Consider two goods x and y, with prices px and py , respectively. A 0.07 percent
value tax on these two goods does not affect the relative price of x in terms of y.
(i) [4 pts.] The marginal rate of substitution measures the rate at which the market is willing
to substitute one good for the other.
(j) [4 pts.] An indifference curve represents the collection of all the bundles that a consumer
can buy.

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Econ 73-250A-F

Andy’s monthly income is $400.

u1 (x,y) = 0.3 log(x) + 0.6 log(y)

(f) [4 pts.] If the following condition holds

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