Economics 310, Chapter 3 and 4 Homework

09/19/2002

Instructions: If you are in the 12:30 PM class, do problem 1. If you are in the 3:30 PM do problem 2.

Question 1. Hashem is the CEO of a large company and earns $100 per hour. He typically works 40 hours per week and pays 40% of his income in taxes.

  1. Draw his weekly before and after tax budget line and indifference curves between leisure and consumption.
  2. Suppose President Bush passes a tax cut bill which provides for a $1000 lump sum rebate in Hashem’s taxes.
  3. Graphically show the effect of the tax cut on Hashem’s consumption of goods and leisure assuming that leisure is a normal good.
  4. What effect will the tax cut have on the production of goods and services. Explain and show on your graph. Show the substitution and income effects of the tax cut on your graph.
  5. Suppose President Bush reduced Hashem’s taxes by cutting the rate he pays rather than giving a lump sum rebate.
  6. How much would Hashem’s rate have to be reduced to generate a $1000 reduction in Hashem’s taxes?
  7. Show the effect of such a rate cut on Hashem’s budget line.
  8. Which type of tax cut, a $1000 lump sum rebate or a rate reduction which reduces Hashem’s taxes by $1000, would have a greater effect on the production of goods and services. Explain and depict.

Question 2. Consider a person with a $50 per week to spend on entertainment. Every week he can either spend his budget going to the movies or bar hopping. A ticket to the movies costs $10 and a drink at the local bar is $5.

1.      Draw his budget line and indifference curves if he buys 4 movie tickets per week and spends the rest of his income at the local bar.

2.      Suppose his entertainment budget increased to $80 per week and you observe him buy 5 movie tickets each week. Show the effect of the increase in budget if both movies and drinks are normal goods.

3.      Depict the change cause by increasing his budget if movies are inferior and drinks are normal.

4.      Suppose the old local movie theater is torn down and replaced by a new multiplex with stadium style seating, digital sound, huge screens, and more comfortable seats. Viewing a movie is much more enjoyable. At the same time, the theater raises the price of movie tickets to $12.50.

a.      What effect will this have on the person’s budget line between movies and drinks? Show graphically.

b.      What effect will this have on the person’s indifference curves between movies and drinks. Show graphically.

c.      Explain the effect on the person’s indifference curves using the concept of Marginal Rate of Substitution.

d.      Show the dual effect of the change in the price of tickets and the new movie theatre assuming both movie tickets and drinks are normal.

e.      True, false, uncertain. Explain. The total expenditure on movies will increase.