1. Henry’s preferences over meat and potatoes are complete, transitive, monotonic and convex.
If
the price of meat rises, he buys less meat and more potatoes. Based on this, which of the
following statements is necessarily correct?
a. Meat is inferior, and potatoes are normal.
b. Meat is normal, and potatoes are inferior.
c. We can only conclude that potatoes are normal.
d. We can only conclude that meat is normal.
e. We cannot make any conclusions about whether meat and potatoes are normal or inferior.
2. Orlando’s preferences over goods X and Y are complete, transitive, monotonic and convex. His
price consumption curve, as the price of good X changes, is a horizontal line. Based on this
information, we can say that
a. X is necessarily a normal good.
b. X is necessarily an inferior good.
c. Y is necessarily a normal good.
d. Y is necessarily an inferior good.
e. None of the above.
3. Assume that preferences are complete, transitive, monotonic and convex and consider the
truthfulness of the following statements.
I. If Doug’s price elasticity of demand for good x is zero, good x must be an inferior good.
II. If price elasticity of demand for good x is negative, good x must be a normal good.
a. Only statement I is true.
b. Only statement II is true.
c. Both statements I and II are true.
d. Neither statement is true.
4. Assume that preferences are complete, transitive, monotonic and convex and consider the
truthfulness of the following statements.
I. If Doug’s income consumption curve for good x and good y is upward sloping, the
demand curve for good y must be downward sloping.
II. If the Engel curve for good x is vertical, then the law of demand must hold for good x.
a. Only statement I is true.
b. Only statement II is true.
c. Both statements I and II are true.
d. Neither statement is true.
5. Assume that preferences are complete, transitive, montonic and convex. If a good’s income
elasticity of demand is negative, then the good
a. never follows the law of demand.
b. always follows the law of demand.
c. follows the law of demand if the income effect of a change in its price is stronger than the
substitution effect.
d. follows the law of demand if the substitution effect of a change in its price is strong than the
income effect.
6. Assume preferences are complete, transitive, monotonic and convex. If the income consumption
curve for good x and good y is horizontal, the price consumption curve (as the price of x
changes)
a. must be downward sloping.
b. must be upward sloping.
c. must be horizontal.
d. must be vertical.
e. is indeterminant.
7. Suppose an individual’s utility function is 𝑈(𝑋, 𝑌) = 𝑋𝑌, and his total budget is $24. The price
of Y is always $1, but the price of X decreases from $4 to $1. Calculate the substitution effect
on X and Y.
a. X: +9; Y: +0
b. X: +6; Y: -6
c. X: -6; Y: +6
d. X: +3; Y: -6
e. X: -6; Y: +12
8. Suppose an individual’s utility function is 𝑈(𝑥, 𝑦) = √𝑥 + √𝑦, and his total budget is $50. The
price of y is always $1, but the price of x increases from $1 to $4. Calculate the income effect
on x and y.
a. X: -21; Y: +39
b. X: -1.5; Y: -24
c. X: -22.5; Y: +15
d. X: -13.9; Y: +19.4
e. X: -16; Y: +11
9. Suppose an individual’s utility function is U = x1/2 + y, and her total budget is $48. The price of
y is always $8, but the price of x increases from $1 to $2. Calculate the substitution effect on y
and the income effect on x.
a. SE= +2 Y; IE= +0 X
b. SE= -1 Y; IE= - 12 X
c. SE= +1 Y; IE= + 12 X
d. SE= -2 Y; IE= +0 X
10. A consumer's original utility maximizing market basket of goods is shown in the figure as
Bundle A. Following a price change, the consumer's utility maximizing market basket changes to
Bundle C. Which of the following statements is necessarily FALSE?
a. Good X is a Giffen good.
b. Good Y is a normal good.
c. The price consumption curve as Px changes slopes upward.
d. The income consumption curve slopes downward.
e. Cross-price elasticity of demand for good y with respect to Px is negative.
Long Form Questions
1. Jill possesses $160,000 worth of valuables. She faces a 0.02 probability of a burglary, where
she would lose jewelry worth $70,000. Her utility function is U = 4X1/2, where X is final
worth in dollars. Show your work for each part below.
a. Calculate AND interpret Jill’s risk premium. (9 points)
b. What is the most that Jill would be willing to pay for an insurance policy that fully covers
her against loss? (8 points)
2. Rosa has a 10% chance of getting sick in the next year. If she gets sick, her medical bills will
0.5
amount to $500. She has a wealth of $1,000. Suppose she has the utility function u(x) = x ,
where x is her net wealth at the end of the year.
a. Calculate AND interpret Rosa’s risk premium. (9 points)
b. What is the most that Rosa is willing to pay for an insurance policy that fully covers
against her loss? (8 points)
c. Some insurance policies have deductibles. A deductible is an amount of a claim not
covered by insurance; it’s a fixed portion of the medical bills that the insured person must
pay in order to make a claim to their insurer. Suppose Rosa’s insurance company
provides two plans. Plan A has zero deductibles (good!) but charges a high premium
(bad!). Specifically, Plan A charges $55 for $500 of coverage. Plan B has a deductible of
$K, where K<500, but charges a premium of just $(55 – .1K). Suppose K =$300. Will
Rosa purchase insurance and, if so, which plan? Show this mathematically. (9 points)
3. Jill possesses $160,000 worth of valuables. She faces a 0.02 probability of a burglary, where
she would lose jewelry worth $70,000. Her utility function is u(x) = 4x1/2, where x is final
wealth. What is the most that Jill is willing to pay for an insurance policy that fully covers
against loss?