Problem Set 3, ECN 210, is due in Class on Friday, Oct. 11th, 2013 Problem 1.

The tables below report total current consumption expenditures and expenditures on certain major categories of goods for 5 different income groups in the United States in 1961. People within each of these groups all had similar incomes. Group A is the lowest income group and Group E in the highest. Table 1. Expenditure by Category for Various Income Groups, 1961
A Food Prepared at Home Food Away from Home Housing Clothing Transportation Other Total Expenditures 465 68 626 119 139 364 1781 Income Groups B C 783 171 1090 328 519 745 3636 1078 213 1508 508 826 1039 5172 D 1382 384 2043 830 1222 1554 7415 E 1848 872 4205 1745 2048 3490 14208

Table 2. Percentage Allocation of Family Budget

A Food Prepared at Home Food Away from Home Housing Clothing Transportation 26.1 3.8 35.1 6.7 7.8 Income Groups B C 21.5 4.7 30.0 9.0 14.3 20.8 4.1 29.2 D 18.6 5.2 E 13.0 6.1

(a) Complete Table 2. (b) Which of these goods are normal goods? (c) Which of these goods are luxury goods at most income levels? (d) Which of these good are necessity goods at most income levels? (e) Draw the Engel curve for one of the luxury goods mentioned in part (c). (f) Draw the Engle curve for one of the necessity goods mentioned in Part (d). (g) How does the shape of an Engel curve for a luxury differ from the shape of an Engel curve for a necessity?
(Hint: In drawing the Engel curves, use total expenditure on current consumption as income.) 1

Problem 2. Suppose the demand for cigarettes is Q = 15 - 0.5P and the supply of cigarettes is Q = P - 3, where P is the price per pack of cigarettes. Suppose the government imposes a cigarette tax of $3 per pack. (a) What is the price paid by producers? (b) What is the price faced by consumers? (c) What is the government revenue from the tax? (d) What is the consumers tax burden (i.e., the total dollar amount of tax revenue that is paid by consumers)? (e) What is the excess burden of the tax? Problem 3. Mr. Adam will only live for two periods. In the first period, he will earn $50,000. In the second period, he will retire and live on the savings. His utility function is U(C1, C2)=C1C2, where C1 is consumption in period 1 and C2 is consumption in period 2. He can borrow and lend in the interest rate r = 0.1. (a) if the interest rate rises, will his period 1 consumption increase, decrease, or stay the same? (b) Would an increase in the interest rate make him consume more or less in the second period? (c) If Mr. Adam's income is 0 in period 1, and $55,000 in period 2, would an increase in the interest rate make him consume more, less, or stay the same amount in period 1?