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Microeconomics An Intuitive Approach With Calculus 2nd Edition by Thomas Nechyba – Test Bank
True / False 
1. Quasilinear goods are borderline goods between the set of normal and the set of inferior goods.

2. Every necessity is a normal good, but not all normal goods are necessities.

3. Every luxury good is a normal good but not every normal good is a luxury.

4. Every Giffen good is a necessity but not every interior good is a necessity.

5. All homothetic goods are normal goods.

6. All quasilinear goods are necessities.

7. Goods with small substitution effects tend to be normal goods.

8. A change in the price of one good cannot leave utility unchanged unless the price change is accompanies by a change in income.

9. Except for the case of Giffen goods, the substitution effect always tells us that a consumer will consume less (or at least no more) of a good whose price has increased.

10. The price of peaches goes up and I observe you buying more strawberries. This implies strawberries must be a normal good.

11. The price of peaches goes up and I observe you buying more strawberries. This implies that strawberries must be an inferior good.

12. The price of peaches goes up and I observe you buying fewer strawberries. This implies strawberries must be a normal good.

13. Bottles of CocaCola and equallysized bottles of Pepsi Cola are perfect substitutes for a consumer, but a bottle of Coke costs 10 cents less than bottles of Pepsi. The income effect of a 15 cent increase in the price of Pepsi will be for the consumer to drink less cola.

14. Bag of chips and bottles of salsa are perfect complements for consumer who eats only chips and salsa, but a bottle of salsa costs $1 more than a bag of chips. The income effect of a 50 cent increase in the price of a bag of chips will be fore the consumer to eat fewer chips and less salsa.

15. Income effects are negative for normal goods, and positive for inferior goods.

16. Homothetic goods are neither necessities nor luxuries, but rather lie on the borderline between them.

Multiple Choice 
17. The price of peaches goes up and I observe you buying fewer strawberries. Which of the following is consistent with this observation:

18. You and I both have homothetic tastes. When the price of peaches goes up, you buy more strawberries and I buy fewer. Which of the following must be true.

19. At most museums, you can either buy a yearlong membership that gives you free access to the museum any time, or you can pay a daily fee every time you visit. (Assume for purposes of this exercise that everyone can in principle afford the yearlong membership.)

20. Wholesale clubs charge a fixed monthly fee but then offer goods at discount prices. For purposes of this question, suppose a wholesale club and a supermarket offer the same composite grocery item, with the supermarket charging no fixed fee but a higher price for the item. (Assume no corner solutions.)

21. Suppose the government spends the same for a particular consumer under two different policies: One subsidizes the price of good x while the other is a lump sum subsidy. Which of the following is true.

Subjective Short Answer 
22. Currently. the price of consuming housing is lowered by the fact that home mortgage interest is tax deductible. Suppose the government proposed to eliminate this implicit subsidy of your housing consumption, raising the price from to . At the same time, the government lowers the tax on other consumption, lowering the price from to .
a. Write down your original budget constraint assuming the consumer has income I.

23. Suppose your tastes are defined by the utility function .
a. Suppose your income is $1,000, the price of is 1 and the price of is . Set up your utility maximization problem.

24. Suppose you collect stamps and coins for the sheer fun of it. Currently, your collection contains both. For purposes of this problem, suppose that stamps all sell for one price and coins all sell for another, and both are normal goods.
a. Begin by illustrating your current budget constraint (with stamps on the horizontal and coins on the vertical) as well as the bundle A you currently own. Assume that you have done the best you can given your circumstances.

25. Your drink budget is entirely split between bottled water and fancy liqueurs, and your tastes are quasilinear in bottled water. In an attempt to get people to drink more water, the government introduces a subsidy that lowers the price of bottled water.
a. In a graph with bottled water on the horizontal and fancy liqueurs on the vertical axis, illustrate your beforesubsidy budget and your optimal bundle A.

26. Suppose a relatively low income family has a monthly budget of $1,000 to allocate between food and a nonfood composite good. In this problem, assume food is aggregated into a “composite food” good that is modeled on the horizontal axis, and the nonfood composite good is denominated in “dollars of other consumption”. The price of food is $10 per unit. Suppose further that this family’s tastes exhibit kinks in indifference curves, with one such indifference curve graphed below.
a. Draw the family’s budget constraint and label the optimal consumption bundle. b. Due to unexpected droughts, the price of food rises to $20. A cash subsidy S that leaves our family with the same level of happiness as it enjoyed prior to the price increase is proposed. How much would this subsidy cost for this family? c. An alternative proposal suggests a price subsidy s that lowers the price of food for this family from $20 to ($20s), with s set sufficiently high to allow the family to reach its original utility level. d. Yet a third proposal suggests a price subsidy that leaves in tact the new price of $20 for the first 20 units of food bought by the family but then lowers the price for this family to $(20s’) while also making the family just as happy as it was before. How high does s’ have to be to accomplish this? e. If cost is all you care about, how would you rank these three policies? What if you care about food consumption for this family and believe a policy is better if it results in more food consumption?

27. Suppose the only two goods you care about in the world are French wine (x) and Cuban cigars (y) and your utility function is given by u(x,y)=xy. You have no income, and the only thing in the world you possess is a large box you have just inherited from your rich uncle who passed away last week (of liver and lung cancer.) You open the box, and much to your liking, you find it contains 9 bottles of fine French wine and 3 boxes of exquisite Cuban cigars. Currently, the wine sells for $1 per bottle, and the cigars sell for $9 per box. Just as you receive the inheritance, you read the headline: “President Lifts Embargo – Price of Cuban Cigars Falls to $4 per Box!”
a. Determine the income (or wealth) and substitution effects of a decrease of the price of cigars from 9 to 4. (Assume fractions of bottles and cigars can be bought.)
