Economics 310, Homework

Fall 2002

09/12/2002

 

Instructions: If you are in the 12:30 PM class do questions 1 and 2. If you are in the 3:30 PM class, do questions 3 and 4.

Question 1. Suppose the only two goods you consume are X and Y . One day the price of X goes up and you respond by increasing your consumption of Y . (Please read this carefully and make sure you don’t confuse X with Y !)

a) Use a graph to illustrate the income and substitution effects on your consumption of Y .

b) Of the two effects in part a), which is bigger? Explain how you know.

Question 2. The only goods you consume are eggs and wine. On Monday, you consume basket M. On Tuesday, the price of eggs goes up and you consume basket T. On Wednesday, the price of eggs returns to its Monday level, but the price of wine goes up. You are exactly as happy on Wednesday as on Tuesday. On Wednesday, you consume basket W.

a) Draw a diagram that illustrates your budget lines, indifference curves, and optimum points on all three days.

b) True or False: If you consume fewer eggs on Wednesday than on Monday, then eggs cannot possibly be a Giffen good. Justify your answer by referring to the relative locations of points M, T and W.

 

Question 3. Every week, Roscoe buys 10 pounds of cheese for $5 a pound. True or False: If the price of cheese rises to $7 a pound and Roscoe’s income increases by $20 a week, he’ll be neither better nor worse off than before.

Question 4. The week starts on Monday. On Tuesday your income rises. On Wednesday your income remains at its Tuesday level and the price of X rises. You are just as happy on Wednesday as on Monday. Your optimum points on the three days are M, T and W.

a) In terms of the locations of M, T and W, what does it mean for X to be normal?

b) In terms of the locations of M, T and W, what does it mean for X to be Giffen?

c) Using your answers to a) and b), explain why a normal good cannot be Giffen.