Question 1

Employing a fixed-weight index like the Consumer Price Index to adjust a person's salary in response to inflation will overcompensate this person because doing so will allow this person to

Accepted Answer

A fixed-weight index like the Consumer Price Index (CPI) measures the cost to purchase a fixed basket of goods over time. When salaries are adjusted based on CPI to counteract inflation, individuals might be overcompensated because they can substitute cheaper goods for more expensive ones, thereby achieving a higher level of utility than before inflation. This substitution effect is not accounted for in a fixed-weight index, leading to potential overcompensation.

Question 2

Inflation over time necessarily makes consumers worse off.

Accepted Answer

Wages also increase over time.Workers may earn the price of some goods in less time than in the past.

Question 3

A consumer's utility function is given by:
U(x,y)= 10xy
Currently,the prices of goods x and y are $3 and $5,respectively,and the consumer's income is $150.
a.Find the MRS for this consumer for any given bundle (x,y).
b.Find the optimal consumption bundle for this consumer.
c.Suppose the price of good x doubles.How much income is required so that the consumer is able to purchase the original consumption bundle (if you were unable to solve d. ,then take a guess at what the optimal bundle is before solving this)
d.Now that the price of good x has doubled,how much income is needed for the consumer to reach the original level of utility? Is this more or less that what you found in e.?

Accepted Answer

The answer of A consumer's utility function is given by:
U(x,y)=...

Question 4

When Trina can afford bundles A and B but not C,she purchases bundle A.When Trina can afford bundles A and C,but not B,she purchases bundle C.We can conclude her preference ordering of the three bundles is (in order from most preferred to least)

Accepted Answer

Trina chooses C over A when she can afford both, indicating she prefers C to A. She chooses A over B when she can afford both, indicating she prefers A to B. Therefore, her preference order is C, A, B.

Question 5

Suppose Ian consumes bread and mustard with his income.He views these goods to be Perfect Complements.He currently consumes 15 units of each good each week.Suppose that the price of Mustard increases by $1/unit and bread increases by $2/unit.Ian's union automatically provides him with a CPI adjustment in his income amounting to an increase by $45.Is Ian better off,worse off,the same or is it uncertain as compared to previously? Explain and provide a graph to demonstrate your answer.

Accepted Answer

The answer of Suppose Ian consumes bread and mustard with...

Question 6

According to Revealed Preferences,if a Consumer chooses a more expensive bundle of goods over a cheaper bundle of goods,we can conclude

Accepted Answer

Revealed Preferences theory suggests that a consumer's preferences can be inferred from their observed choices. Therefore, if a consumer chooses a more expensive bundle of goods over a cheaper bundle, it reveals that the consumer prefers the more expensive bundle. This is because if the consumer preferred the cheaper bundle, they would have chosen it instead. Thus, the answer is A.

Question 7

A true cost-of-living adjustment in response to a change in prices would compensate consumers so that they would be able to

Accepted Answer

A true cost-of-living adjustment aims to maintain a consumer's level of utility despite changes in prices, allowing them to achieve the same satisfaction or happiness with their purchases as before the price changes occurred.

Question 8

A Californian student consumes Internet services (I)and books (B).Her preferences are represented by a Cobb-Douglas utility function: U(I,B)= I^1/4^B^1/4 The prices of each good is $2 and the student has an income of $200.Over the course of the past year,the price of internet services has risen to $4,but the price of books has remained the same.The government has decided provide this student with additional money to compensate for the higher price of internet services.In order to determine the transfer the government has three consultants who have made the following suggestions: Consultant A: The student's income should be increased by a percentage found using a consumer price index (CPI). Consultant B: The additional income should allow the student to get her initial level of utility. a.Find the consumer's optimal bundle before the increase in price occurs. b.Find the consumer's optimal bundle after the increase in price occurs with income still at $200. c.Find the amount of the transfer implied by consultant A. d.Is the student necessarily better or worse off than before from such a transfer implied by consultant A? Explain why. e.Is the transfer implied by consultant B more or less than the amount implied by A? Explain. What is the precise dollar amount implied by consultant B?

Accepted Answer

The answer of A Californian student consumes Internet services (I)and...

Question 9

Suppose the typical consumer only purchases food and clothing,and her utility can be expressed as U = F ∗ C.Currently,food costs $5 per unit and clothing costs $2 per unit.Her income is $70.If the price of food increases to $6,compare the resulting Laspeyres price index with a true cost of living index.

Accepted Answer

The answer of Suppose the typical consumer only purchases food...

Question 10

Under which of the following conditions will there be no substitution bias in the CPI?

Accepted Answer

The answer of Under which of the following conditions will...

Question 11

George's parents let him use the family car whenever he wants,but require that he pays for all gas he uses.George has been driving the car 100 miles per week.His parents want to limit how much he drives the family car,but don't want to impose a major burden on his finances.Mom's plan is to charge him a dollar for each ten miles he drives the car (per week),but to increase his allowance by $10.Dad thinks this plan will have no effect on his driving since he is going to get the money back at the end of the week.Who is right? Explain.

Accepted Answer

The answer of George's parents let him use the family...

Question 12

A Californian student consumes Internet services (I)and books (B).Her preferences are represented by a Cobb-Douglas utility function of the type: U(I,B)= I^.5B^.5.Initially Y = 100, P_I = P_B = 1.Lately,however,because of the electricity shortage,the price of the Internet services has increased to 2.The government has decided to give a transfer to the student so that she can recover her initial welfare.In order to determine the transfer the government has hired three consultants who have made the following suggestions: Consultant A: The transfer should allow the student to buy her initial bundle. Consultant B: The transfer should allow the student to get her initial level of utility. Consultant C: The government should give her a transfer of 20. a.Using the expenditure function,find the amount of the transfer implied by consultant A. b.Find the amount of the transfer implied by consultant B. c.Determine whether the consumer is better or worse off from Consultant C's suggestion than before the price increases.

Accepted Answer

The answer of A Californian student consumes Internet services (I)and...

Question 13

Using the CPI to compensate workers for inflation is appropriate because,in the face of a change in relative prices,people should be allowed to purchase the same bundle as they did before the price changes.

Accepted Answer

This assumes that people would still prefer the original bundle.Because they are facing a new set of relative prices,compensating people so that they could purchase the original bundle will allow them to be able to achieve a higher level of utility than they did before the price changes.

Question 14

A consumer purchases housing (H)and spends the remainder of income on the composite good (C).The government is considering one of two policies.Policy A taxes housing by $50 per unit consumed.With the tax in place,the consumer purchases 100 units of housing.Policy B collects a lump-sum tax of $5,000 from the consumer's income.Compare the effects of the policies on the consumer's utility/well-being and the amount of housing and composite goods purchased.

Accepted Answer

The answer of A consumer purchases housing (H)and spends the...

Question 15

Richard receives government transfer payments and currently consumes five guns and six goose livers.Assume the price of guns decreases by 10% and the price of goose liver increases by 20%.The government raises Richard's transfer payments so he can still afford five guns and six goose livers.Does this constitute a true cost-of-living adjustment?

Accepted Answer

The answer of Richard receives government transfer payments and currently...

Question 16

Suppose the only two goods you consume are wine and roses.On Tuesday,the price of wine goes up and at the same time your income increases by just enough so that you are equally happy as you were on Monday.What happens to the amount of wine you consume? Are you able to afford the same bundle as you did on Monday? Use a graph of budget constraints and indifference curves to illustrate your answer.

Accepted Answer

The answer of Suppose the only two goods you consume...

Question 17

Andrew's union has signed a new wage contract for the coming year.It promises to increase Andrew's wages in the next year so that he can keep on consuming the same bundle of goods when the prices go up.Should Andrew anticipate being happier this year (before prices rise)or next year (after prices rise)? Use a graph to demonstrate how you can tell this.Be clear!

Accepted Answer

The answer of Andrew's union has signed a new wage...

Question 18

Before an uneven rise in prices Allan consumed five bread and six juice.After the price increase and with an increased welfare payment from the government Allan consumes four bread and seven juice.Does the government payment represent a true cost-of-living adjustment?

Accepted Answer

A true cost-of-living adjustment would allow Allan to reach the same level of utility after the price changes, which is possible if the two bundles of goods lie on the same indifference curve. This implies that Allan is able to achieve the same satisfaction or utility from both consumption bundles, despite the change in prices and the adjustment in his consumption pattern.

Question 19

Many elderly people have Social Security payments as their sole source of income.Because of this,there have been attempts to adjust these payments so as to keep up with changing prices.This process is called "indexing";this question will lead you through the process.
Suppose that in the year 2000,a typical Social Security recipient consumed only Food and Housing.The price of housing was $15/unit and the price of food was $5/unit.Denote the quantities of food and housing per month by F and H respectively.This consumer received $150/month and consumed five units of housing and 15 units of food.
a.Write down the algebraic representation of this consumer's budget constraint.
b.Show that the bundle (5,15)is just affordable.Identify another bundle on the budget constraint where both goods are consumed in positive amounts.Suppose that in 2004 the price of food rose to $10/unit and housing rose to $20/unit.
c.How much additional income is required such that the original bundle is just affordable at the new prices.
d.On the graph with Housing on the horizontal axis and food on the vertical axis,depict the original budget constraint and the new budget constraint after income is compensated according to c.Include the indifference curve going through the point (5,15).
f.Is the consumer better,worse,or equally well off in 2004 relative to 2000 following the compensation? Explain.What will happen to the consumer's choice of food and housing consumption? How can you tell?
g.The Laspeyres Price Index,as we have been describing above,measures inflation by looking at how the cost of a particular bundle of goods a consumer purchases in a previous year changes.Critics claim that this measure of inflation overstates changes in the cost of living.Do you agree or disagree? Explain.

Accepted Answer

The answer of Many elderly people have Social Security payments...

Question 20

Under which of the following conditions will there be no substitution bias in the CPI?

Accepted Answer

If all goods change in price by the same percentage, there will be no substitution bias because consumers will not change their purchasing behavior in response to the price changes.

Quiz 4: Demand

Employing a fixed-weight index like the Consumer Price Index to adjust a person's salary in response to inflation will overcompensate this person because doing so will allow this person to

Inflation over time necessarily makes consumers worse off.

When Trina can afford bundles A and B but not C,she purchases bundle A.When Trina can afford bundles A and C,but not B,she purchases bundle C.We can conclude her preference ordering of the three bundles is (in order from most preferred to least)

According to Revealed Preferences,if a Consumer chooses a more expensive bundle of goods over a cheaper bundle of goods,we can conclude

A true cost-of-living adjustment in response to a change in prices would compensate consumers so that they would be able to

Under which of the following conditions will there be no substitution bias in the CPI?

Using the CPI to compensate workers for inflation is appropriate because,in the face of a change in relative prices,people should be allowed to purchase the same bundle as they did before the price changes.

Before an uneven rise in prices Allan consumed five bread and six juice.After the price increase and with an increased welfare payment from the government Allan consumes four bread and seven juice.Does the government payment represent a true cost-of-living adjustment?

Under which of the following conditions will there be no substitution bias in the CPI?