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Compared with an earmarked grant of $100 in food stamps (call this policy B), would policy
A lead to more, less, or the same food consumption? Why? Assume well-behaved
indifference curves.
b) (6 points) Mr. Big is the mayor of Nowhereland and wants people to drink more coffee.
His advisors come up with a great plan: Impose a tax on coffee and keep the revenue. In
addition, impose higher income taxes to raise even more revenue. Under what assumptions
might this plan boost the consumption of coffee (if at all)? Explain using a graph.
c) (7 Points) A consumer is considering choosing a calling plan for her cell phone. The plan
has a fixed monthly fee of $40, and it gives 200 free minutes per month and charges $0.1 for
each additional minute. The consumer has a monthly income of $100, and she spend it on
cell phone and another composite good y, where py =$1. Her utility function is given by U
(x,y) =
, where x is the minutes of cell phone she uses in a month.
Find her optimal consumption bundle. Graph your solution on a diagram including the
budget line and a representative indifference curve.
d) (6 Points) In a perfectly competitive market, there are 100 firm split equally between the
following short run cost functions:
C1 (q1 ) = 2q12 + 10q1 + 200
f) (6 Points) In the long-run equilibrium of a competitive market, the market supply and
demand are:
Supply:
Demand:
P = 30 + 0.50Q
P = 100 1.5Q,
Where P is dollars per unit and Q is rate of production and sales in hundreds of units per day.
A typical firm in this market has a marginal cost of production expressed as:
MC = 3.0 + 15q.
Determine the economic rent that the typical firm enjoys.
Question-2 [10 Points]: A consumer who derives his utility from two goods is characterized
by the following utility function
U(x,y)= min{2x, 5y}
Suppose that the consumer is endowed with an income of 100 (I = 100), and that p x = 10 and
py = 5.
a) (4 Points) Analytically derive this consumer optimal consumption point. Depict the
budget line and optimal consumption point in a well-labeled diagram.
Now suppose the price of declines to 5 (px = 5).
b) (6 Points) Derive analytically and show on the same diagram this consumer new optimal
consumption point. Decompose the change in x consumption into a substitution and an
income effect.
Question-3 [14 Points]: Adam & Eve own separate farms. Depending on the market
conditions Adam has $10,000 profits and Eve only $900 or Eve has $10,000 profits and
Adam only $900. The probability of each state is 50%. Their satisfaction is characterized by:
U=
Adam & Eve think they should work together and merge their farms. If they were to merge
their farms, both would get half of the combined profits.
a) (8 Points) Do you think it is a good idea to merge? Use a graph to illustrate your answer.
b) (6 Points) It turns out that because of all the layers (missing sentence). What is the
maximum sum either one is willing to pay (missing sentence)?
Question-4 [16 Points]: The market demand and supply functions for cotton are:
Qd = 10 4P
Qs = 6P + 5
a) (5 Points) Calculate the consumer surplus and producer surplus and show it on a graph
b) (6 Points) To assist cotoon farmers, the government initiates a subsidy of $0.10 per unit.
Calculate the new level of consumer surplus and producer surplus.
c) (5 Points) Show that the combined increase in consumer and producer surplus is less than
the increased government spending necessary to finance the subsidy. Demonstrate your
answer in your graph for part (a).
b) (7 Points) Find the long-run supply curve? Identify the equilibrium quantity and price?
How many firms will be operating in the long run? Use a graph to demonstrate your solution.
c) (7 Points) Suppose in addition to the firms identified above (parts a & b) there is a single
firm with a production function characterized by: q = 8L0.5K0.5. Find the long-run supply
curve for this firm. Explain briefly how the industry adjusts to the emergence of this firm in
the long run?