Economics 310, Fall 2001First Homework

Prof. Kenneth NgDept. of Economics

COBAECalifornia State University-Northridge

Problem 1-9:30 AM

Question 1. 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.

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.

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.

Show the effect of the increase in budget if movies are inferior and drinks are normal. 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.

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

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

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

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.

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

Movies

Drinks

5

10

8

16

4

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.

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.

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.

Show the effect of the increase in budget if movies are inferior and drinks are normal.

6

normal

inferior

Movies

Drinks

5

8

16

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.

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

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

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.

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

6

6.4

Movies

Drinks

5

8

16

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.

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

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

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.

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

6

6.4

Because the movie theatre is nicer and viewing movies more enjoyable, the value of movies relative to drinks falls.

This causes the slope of the IC, the MRS of drinks, to fall.

Movies

Drinks

5

8

16

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.

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

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

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.

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

6

6.4

Change after rise in price and

construction of new theatre

Change after rise in price

with old theatre

The expenditures on movies is given by:

PmovieQmovies

The price of movies is going up. This by itself would cause an increase in expenditures on movies.

However, the Q of movies bought is also changing. The net change in movie purchases is indeterminate because the construction of the new movie theatre would cause movie consumption to go up, the substitution effect would cause the consumption of movies to go down, and the income effect would cause the consumption of movies to go down.

Therefore, the change in expenditures is indeterminate.

Problem 2-9:30AM

Consider the demand schedule below. Graph the demand curve and show indifference curves and budget lines

that are consistent with the demand schedule on the graphs below. Assume that the good is normal.

Show the substitution and income effects of a change in price from $25 to $50.

Price $50 $25

Quantity 10 40

Price

Quantity

Good

All

Other

Goods

Consider the demand schedule below.

Graph the demand curve and show indifference curves and budget lines that are consistent with the demand schedule on the graphs below. Assume that the good is normal.

Show the substitution and income effects of a change in price from $25 to $50.

Price $50 $25

Quantity 10 40

10 40

$50

$25

10 40

Substitution Effect

Income Effect

Problem 1-2PM Class

Consider a person with a $100 per week to spend on entertainment. Every week he can either spend his budget going to the movies or drinking. A ticket to the movies costs $10 and a drink at the local bar is $5.

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.

Suppose his entertainment budget increased to $180 per week. Show the effect of the increase in budget if movies are inferior and drinks are normal goods.

Show the effect of the increase in budget if both movies and drinks are normal. Suppose the run down dingy old local bar is torn down and replaced by a brand new

fancy bar. Instead of drinking in the old dingy, dark, smelly bar, the new bar is well lit, nicely furnished, has a huge dance floor and is well ventilated. Drinks in the new bar are $10 vs. $5 in the old bar.

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

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

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

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

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

Movies

Drinks20

18

36

4

12

Consider a person with a $100 per week to spend on entertainment. Every week he can either spend his budget going to the movies or drinking. A ticket to the movies costs $10 and a drink at the local bar is $5.

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.

Suppose his entertainment budget increased to $180 per week. Show the effect of the increase in budget if movies are inferior and drinks are normal goods.

Show the effect of the increase in budget if both movies and drinks are normal.10

normal

inferior

Movies

Drinks

18

36

Suppose the run down dingy old local bar is torn down and replaced by a brand new fancy bar. Instead of drinking in the old dingy, dark, smelly bar, the new bar is well lit, nicely furnished, has a huge dance floor and is well ventilated. Drinks in the new bar are $10 vs. $5 in the old bar.

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

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

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

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

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

18

Movies

Drinks

8

16

Suppose the run down dingy old local bar is torn down and replaced by a brand new fancy bar. Instead of drinking in the old dingy, dark, smelly bar, the new bar is well lit, nicely furnished, has a huge dance floor and is well ventilated. Drinks in the new bar are $10 vs. $5 in the old bar.

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

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

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

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

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

8

Because the bar is nicer and and drinking in the new bar is more enjoyable, the value of drinks relative to movies rise.

This causes the slope of the IC, the MRS of drinks, to rise.

Movies

Drinks

8

16

Suppose the run down dingy old local bar is torn down and replaced by a brand new fancy bar. Instead of drinking in the old dingy, dark, smelly bar, the new bar is well lit, nicely furnished, has a huge dance floor and is well ventilated. Drinks in the new bar are $10 vs. $5 in the old bar.

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

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

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

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

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

Change after rise in price and

construction of new bar

Change after rise in price with old bar

The expenditures on drinks is given by:

PdrinksQdrinks

The price of is staying the same. This by itself would cause no change in expenditures on movies.

However, the Q of drinks bought is changing. The net change in drink purchases is indeterminate because the construction of the new bar would cause drink consumption to go up, the substitution effect of the change in drink prices would cause the consumption of drinks to go down, and the income effect would cause the consumption of drinks to go down.

Therefore, the change in expenditures is indeterminate.

Problem 2-2 PM

Consider the demand schedule below. Graph the demand curve and show indifference curves and budget lines

that are consistent with the demand schedule on the graphs below. Assume that the good is normal.

Show the substitution and income effects of a change in price from $75 to $10.

Price $75 $10

Quantity 10 40

Price

Quantity

Good

All

Other

Goods

Consider the demand schedule below.

Graph the demand curve and show indifference curves and budget lines that are consistent with the demand schedule on the graphs below. Assume that the good is normal.

Show the substitution and income effects of a change in price from $75 to $10.

10 40

$75

$10

10 40

Price $75 $10

Quantity 10 40

Substitution Effect

Income Effect

Exam Notes

Closed note. Closed book.No Blue Book Required.Calculator allowed. Memory must be

purged before exam.Exam will emphasize basic understanding

of economic concepts and their application to the real world plus the ability to engage in economic analysis using the tools from lecture and textbook.