Topic 3 Practice Questions

1. The price-consumption curve:

A) traces the utility-maximizing combinations of two goods as the price of one good changes, holding income constant.

B) measures the quantity of a good consumed related to income.

C) measures the quantity of a good that all consumers in a market will buy for its price.

D) shows the set of all baskets for which the consumer is indifferent.

 

Correct Answer: A

 

2. Rachel consumes only two goods, x and y. Her utility function is U = 2xy. The initial price of x is $6, but it then drops to $3. The price of y is $2, and her weekly income is $60. Find the initial basket, decomposition basket, and final basket. Round to the nearest whole number.

 

Answer:

Initially, P_x = $6, P_y = $2, and I = 60

First, find the initial optimal basket.

MRS_x,y = MU_x/MU_y = 2y/2x = y/x

Tangency condition: MRS_x,y = P_x/P_y

y/x = 6/2 = 3, so y=3x

Budget constraint: 60 = 6x + 2y

Sub y = 3x into the budget constraint,

60 = 6x + 2(3x)

At the initial optimal basket: x = 5, y = 15

The initial utility is equal to: U = 2xy = 2(5)(15) = 150.

Next, find the new basket with P_x’ = 3.

The new tangency condition: y/x = P_x’/P_y = 3/2, so y = 3x/2.

Sub y = 3x/2 into the new budget constraint 60 = 3x + 2y

60 = 3x + 2(3x/2)

At the final basket: x = 10, y = 15.

Find the decomposition basket:

Tangency condition: MRSx,y = P_x’/P_y

y/x = P_x’/P_y = 3/2, so y = 3x/2.

U = 2xy = 2x(3x/2) = 150 = U(initial)

So, 3x² = 150

X = 7.07, y = 10.61

Rounding to the nearest whole number, we have x = 7, and y = 11.

At the decomposition basket: x = 7, and y = 11.

 

3. The demand for packed mix-spring salad is given by Q = 480 – 0.3P. The consumer surplus at P = $20 is:

A) $0

B) $24

C) $474

D) $374,460

E) $1,600

 

Correct Answer: D

Steps:

When P = 20, Q = 480 – 0.3 x 20 = 474

Find the vertical intercept of the demand curve:

Set Q = 0, P = 480/0.3 = 1,600

CS = 0.5 *(1,600-20) *474 = 374,460

 

4. Suppose that the demand for butter is elastic at the current price. If the price of butter increases, the total expenditure on butter by consumers will ___________.

A) remain unchanged

B) increase

C) decrease

D) none of the above

 

Correct Answer: C

Explanation:

When demand is elastic, price and total expenditure move in opposite directions. An increase in the price will result in a decrease in total expenditure.

 

5. Suppose that you consume Good A and Good B. Good A is on the x-axis, and Good B is on the y-axis. Assume that the price of Good A decreases.

• The optimal basket before the price change contains Q_A = 2 and Q_B = 4.
• The optimal basket after the price change contains Q_A = 4 and Q_B = 6.
• The decomposition basket contains Q_A = 5 and Q_B = 1.

Based on this information, select the correct statement.

A) The substitution effect is positive, the income effect is negative, and the substitution effect dominates.

B) The substitution effect is negative, the income effect is positive, and the substitution effect dominates.

C) The substitution effect is positive, the income effect is negative, and the income effect dominates.

D) The substitution effect is negative, the income effect is positive, and the income effect dominates.

 

Correct Answer: A

Explanation:

Based on the information presented, the substitution effect is 5 – 2 = 3, and the income effect is 4 – 5 = -1. Thus, the substitution effect is positive and the income effect is negative. Since the absolute value of the substitution effect is greater than the absolute value of the income effect, the substitution effect dominates.

 

6. CR7 and Nike released a new shoe called “CR7 edition 6”. Once the shoes were released, they quickly became popular among fans of Nike and CR7. After the first week of their release, more and more people wished to own the shoes because others did. The new shoes are subject to the___________ network externality.

A) negative and positive

B) negative

C) positive

D) neutral

 

Correct Answer: C

 

7. Assume that the demand curve for Airpods is given as: Q = 100 – 0.2P. What is the consumer surplus at P = $219.99?

A) $280.01

B) $7840.56

C) $7129.92

D) $219.99

 

Correct Answer: B

Explanation:

When P = 219.99, Q = 100 – 0.2P = 56.002

Find the vertical intercept of the demand curve:

Set Q = 0, P = 100/0.2 = 500

CS = 0.5 *(500-219.99) *56.002 = $7840.56

 

8. Which of the following statements is true?

A) The bandwagon effect tends to decrease a consumer’s wishes to buy.

B) Both the snob effect and bandwagon effect do not influence the consumer’s behaviour.

C) The snob effect is illustrated when Bob feels like he should create a TikTok account because all his classmates have one.

D) The bandwagon effect has led people to begin purchasing and wearing a particular clothing style as they see others adopt the same fashions.

E) Both C & D are correct.

 

Correct Answer: D

 

9. The network externality where consumers wish to own exclusive or unique goods is called the __________. This effect can cause the demand curve to shift to the ______ when the price of the good falls.

A) Bandwagon effect, right

B) Bandwagon effect, left

C) Snob effect, right

D) Snob effect, left

 

Correct Answer: D

Explanation:

The snob effect is a negative network externality where consumers prefer to own exclusive goods leading to a higher demand when the prices are high and lower demand when the prices are low. In this example, the price falls, so fewer people would want to buy the good, causing the demand curve to shift to the left due to the snob effect.

 

10. Consider a U-shaped price-consumption curve. On which portion of the price-consumption curve are the two goods considered substitutes?

A) Upward sloping portion

B) Downward sloping portion

C) Both A & B

D) Not enough information to determine the answer

 

Correct Answer: B

Explanation:

Good X and Good Y are substitutes on the downward-sloping portion of the price-consumption curve. Over the upward-sloping portion of the price-consumption curve, the two goods are complements.

 

11. Under what conditions is the network externality classified as a positive network externality?

A) If the quantity of the good demanded by the typical consumer increases in response to the growth in purchases of other consumers.

B) If the quantity of the good demanded by the typical consumer decreases in response to the growth in purchases of other consumers.

C) If the quantity of the good demanded by the typical consumer remains the same in response to the growth in purchases of other consumers.

D) None of the above.

 

Correct Answer: A

 

12. Suppose that the demand for lamb is given as Q_d = 300 – 6P. What is the price elasticity of demand if the price of lamb is $15 per pound? If the price of lamb is increased to a price slightly above $15, how would total expenditure by consumers change?

A) -0.43. Total expenditures for lamb will rise.

B) -1. Total expenditures for lamb will be unchanged.

C) -0.5. Total expenditures for lamb will decrease.

D) 0. Total expenditures for lamb will increase.

 

Correct Answer: A

Explanation:

The price elasticity of demand E_d= %∆Q/%∆P = (∆Q/∆P)*(P/Q). At P = 15, Qd = 300 – 6*15 = 210.

E_d = -6*(15/210) = -0.43. The demand is inelastic at P = 15. When demand is inelastic, price and total expenditure move in the same direction. An increase in the price of a good will result in an increase in total expenditure on it.

 

13. Which of the following statements is NOT true?

A) If the price of the good on the x-axis decreases, the budget line will rotate outward.

B) At a point on the price-consumption curve, the slope of the indifference curve is greater than the slope of the budget line.

C) If the slope of the price-consumption curve is positive, the two goods are complements.

D) The price-consumption curve traces the optimal bundles as the price of one good changes, holding income constant.

 

Correct Answer: B

Explanation:

Any point on the price-consumption curve is a utility-maximizing combination of two goods. At a particular point, the indifference curve and the budget line that pass through this point should have equal slopes.

 

14. Arya only consumes two goods: X and Y. When the price of X changes, the income effect and the substitution effect for X move in opposite directions. In addition, the income effect for X dominates the substitution effect. X must be: ________________.

A) a Giffen good for Arya.

B) an inferior good for Arya.

C) a normal good for Arya.

D) perfect substitutes for Arya.

E) Both a and b are true.

 

Correct Answer: E

 

15. Marina decides to purchase a ring made from an alloy composed exclusively of gold (G) and titanium (T). The price of gold is $60 per gram, and the price of titanium is $30 per gram. Her total budget for the ring is $600. Her utility function is given by U(G,T)=GT. Suppose the price of titanium falls to $20 per gram.

(i) Find the initial consumption basket.

(ii) Find the final consumption basket.

(iii) Find the decomposition basket.

 

Steps:

Initially, P_G = $60, P_T = $30, and I = 600

(i) First, find the original optimal basket:

Tangency condition:

MRS_G,T = P_G/P_T

T/G = 60/30

T/G = 2

T = 2G

Budget constraint:

600 = 60G + 30T

Sub T = 2G into the budget constraint:

600 = 60G + 30(2G)

600 = 120G

G = 5, T = 10

At the original basket, G = 5, T = 10

(ii) Find the new basket with P_T’ = 20.

Tangency condition:

MRS_G,T = P_G/P_T‘

T/G = 60/20

T/G = 3

T = 3G

Sub T = 3G into the new budget constraint:

600 = 60G + 20T

600 = 60G + 20(3G)

600 = 120G

G = 5, T = 15

At the final basket, G = 5, T = 15.

(iii) Find the decomposition basket:

Consuming the original basket, U = GT = 50

New tangency condition:

Sub T = 3G into U = GT = 50:

50=G(3G)

50=3G²

G ≈ 4.08, T ≈ 12.24

At the decomposition basket, G = 4.08, T = 12.24.

 

16. A 2010 study found that gold’s short-run price elasticity of demand in China is -0.4, and the long-run price elasticity of demand is -1.2. Suppose the Chinese government recently increased the price of gold. Consumer expenditures will ______over the short-run and _______over the long-run.

A) decrease; not change

B) increase; not change

C) decrease; increase

D) increase; decrease

E) not change; not change

 

Correct Answer: D

Steps:

• When demand is inelastic, price and total expenditure move in the same direction. An increase in the price of a good will result in an increase in total expenditure for it.
• When demand is elastic, price and total expenditure move in opposite directions. An increase in the price of a good will result in a decrease in total expenditure for it.

 

17. What happens to the quantity demanded for a good in a particular market when all of the individual demand in this market for this good is cut in half? Assume the price level is unchanged.

A) The result is no change to the market demand curve as the new individual demand curves are still proportional to their original demand curves.

B) This results in ½ the quantity demanded in the market demand curve.

C) This results in ⅛ the quantity demanded in the market demand curve.

D) The result is no change to the market demand curve as the market demand curve is independent of the change in individual demand curves.

 

Correct Answer: B

Steps:

The market demand curve is derived by horizontally adding the individual demand curves in the market.

 

18. Suppose that the burger market consists of three firms: McDonald’s, Wendy’s, and Burger King. The demand curves for their burgers are:

McDonalds: Q_MC = 7 – 0.3P

Wendy’s: Q_WE = 6 – 0.2P

Burger King: Q_BK = 4 – 0.4P

Derive the market demand curve. What is the quantity demanded in the market (Q_Total) when the price of a burger is $4?

A) Q_Total = 17.6

B) Q_Total = 13.6

C) Q_Total = 13.4

D) Q_Total = 13.8

E) Q_Total = 17.2

 

Correct Answer: C

Steps:

Add the individual firms’ demand curves horizontally:

The market demand function is: Q_Total = 17 – 0.9P

At P = $4, Q_Total = 13.4.

Substituting P = $4 into individual demand function, Q_MC = 5.8, Q_WE = 5.2, Q_BK = 2.4