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Multiple Choice Questions on S&D, Demand, and Consumer Choice

Question 1

I. Multiple Choice

1. The model of S&D predicts that in equilibrium, making it legal to buy and sell concealed weapons would

A. increase price and decrease quantity purchased.

B. increase quantity purchased and have an indeterminate effect on price.

C. increase quantity purchased and increase price.

D. increase price and have an indeterminate effect on quantity purchased.

2. If a person buys 8 packs of cigarettes per week (regardless of fluctuations in the price of cigarettes), one can conclude that this person’s demand for cigarettes has an

A. elasticity of demand = 0.

B. elasticity of demand = 1.

C. elasticity of demand which is infinite.

D. none of the above answers is correct.

3. If the market demand curve for a good is P = 800 - 4Q, which of the following statements is true?

A. Price elasticity of demand interval from P = \$550 to P = \$540 is greater than price elasticity over the demand interval from P = \$500 to P = \$510.

B. Price elasticity at P = \$400 is equal to one.

C. Buyers’ total expenditures are maximized when P = 400 and Q = 100.

D. All of the above statements are true.

4. Suppose there is a binding price ceiling on interest rates charged on credit cards. Now suppose the price ceiling is increased. Based on the precise terminology of the S&D model,

A. supply of credit cards would increase.

B. demand for credit cards would increase.

C. supply of credit cards would decrease.

D. demand for credit cards would decrease.

E. None of the above are true statements regarding the S&D model.

5. Which of the following statements is TRUE?

A. Moving downward along all negatively sloped demand curves, results in a decrease in the elasticity of demand.

B. At a particular point on a demand curve, the marginal revenue from an increase in quantity is negative if demand is inelastic.

C. An increase in supply must result in an increase in the elasticity of demand due to a lower equilibrium price.

D. All of the above are TRUE.

6. Which of the following cases illustrates a situation where demand is most price inelastic?

A. Wage rates for clerical workers increase by 20% and the number of workers hired decreases by 40%.

B. Prices for theater tickets fall by 10% and the number of tickets sold increases by 12%.

C. Gasoline prices fall from \$2.25 per gallon to \$2.00 per gallon and total sales revenue increases from \$100,000 per month to \$190,000 per month.

## Question 2

D. Gasoline prices rise from \$2.00 per gallon to \$2.25 per gallon and total sales revenue increases from \$500,000/month to \$600,000/month.

7. Suppose the MRSXforY equals 2. This implies

A. the MUX = 2 MUY.

B. the MUY = 2 MUX.

C. the PY=2PX.

D. the PY=2PX.

8. Based on the consumer model of constrained optimization, if the price of good A equals that of good B then at the point of constrained maximization

A. the TU from A must be equal the TU from B.

B. the consumers indifference curves in relation to A and B must have a slope of negative 1.

C. the consumer must buy the same units of B and A.

D. None of the above are correct.

9. Which of the following statements regarding the implications of the theory of consumer choice is FALSE?

With quantity of Y on the vertical axis and quantity of X on the horizontal axis,

A. if X is an inferior good and Y is a normal good, the income-consumption path is negatively sloped.

B. if X is an inferior good and Y is a normal good, the indifference curves are positively sloped.

C. if X is a normal good, then the consumer’s demand curve for X is negatively sloped.

D. All of the above are false statements.

10. In a two-good setting, which of the following statements about the theory of consumer choice is TRUE?

A. Moving along a consumer’s income-consumption path, MRSXforY remains constant.

B. Moving along a consumer’s demand curve for good X, MRSXforY remains constant.

C. Moving along a consumer’s price-consumption curve, MRSXforY remains constant.

D. None of the above statements are true.

11. If an individual’s demand curve for a good A is P = 500 - 2Q, which of the following statements is TRUE? With good A plotted on the horizontal axis,

A. the total expenditures curve is negatively sloped over the demand interval from P = \$220 to P = \$180.

B. the price-consumption curve is negatively sloped over the demand interval from P = \$310 to P = \$290.

C. MR is positive when price is less than \$250.

D. MR is zero when quantity is 250.

12. In a world with two goods, A&B, with good B plotted on the vertical axis and good A on the horizontal axis, suppose a decrease in the price of good B leads to a price consumption curve for good B that is vertical, this would imply

## Question 3

A. good B has an inelastic demand and good B an elastic demand.

B. good B has an elastic demand and good B an elastic demand.

C. good B has a unitary elastic demand and expenditures on good B are constant.

D. good B has an inelastic demand and expenditures on good B are constant

13. Suppose the demand curve for good A is perfectly inelastic over some price range. In this price range

A. the substitution effect equals the absolute value of the negative income effect.

B. the substitution effect is twice the income effect.

C. the income effect is zero.

D. None of the above would be true.

14. Good X would have an upward sloping demand curve over some range of prices if

A. the Engel curve (with X measured on the horizontal axis) is upward sloping.

B. X is inferior, and the substitution effect is smaller than the absolute value of the income effect.

C. X is a normal good, but the substitution effect of a price change is greater than the absolute value of the income effect.

D. All of the above are correct.

15. The expected utility of a two outcome gamble is defined as

A. the utility one places on winning a gamble.

B. the weighted probability of the dollar value of each outcome of the gamble.

C. the weighted probability of the utilities of both outcomes of the gamble.

D. the utility one gains from the best outcome of the gamble minus the utility one gains (or loses) from the worst outcome of the gamble.

16. If a decision maker is risk loving, it implies

A. the utility from the expected value of a lottery is less than the expected utility from the lottery.

B. the decision makers reservation price for the lottery is less than the expected value.

C. the decision maker’s total utility is decreasing as wealth increases beyond a particular threshold of risk.

D. All of the above are true for a risk loving decision maker.

17. Which of the following statements is false?

A. expected utility is the same as utility of the expected value.

B. risk aversion implies a declining marginal utility of wealth.

C. risk neutrality implies constant marginal utility of wealth.

D. All of the above statements are False.

18. Present value of a future payment (Z), 10 years from now (with interest rate “r”) equals

## Question 4

A. Z/(1+r)

B. Z/(1+r)10

C. Z(1+r)

D. Z(1+r)10

Bonus

19. Which of the following represents a case of discounted utility?

A. the future value of a long term interest earning bond.

B. the present value of a good that has inelastic demand.

C. utility that is undervalued, for instance in the case of an inferior good.

D. the present value of a future event or payment.

1. Assume the market equilibrium price and quantity for gasoline are \$2.50 and 100 million respectively. Now, assume the per gallon tax on sellers of gasoline is increased by \$1 per gallon. Using a S&D model, show graphically how this tax increase would affect the market equilibrium for gasoline in the case where the burden of the tax falls entirely on the buyer and equilibrium quantity falls from 100 million to 80 million.

2. If total revenue = TR = P*Q, using calculus solve for dTR/dQ in a form that shows the relationship between TR and the elasticity of demand. For full credit, you must show your work.

3. Suppose the demand function for good X is given by: Qx = 20*(1/Px)

a) Plot this demand curve

b) For this demand curve, the elasticity of demand equals and total expenditures are as price changes

4. Using appropriate budget lines and indifference curves for two goods, A and B, with good A on the horizontal axis, draw a well labeled graph to show the following depiction of a consumer’s commodity choices where the individual is consuming 20 units of A.

Show the decomposition of substitution and income effects for the case where the price of Good A decreases, good A is a normal good, the substitution effect = 5 units and the income effect = 5 units.

5. Using appropriate budget lines and indifference curves for two goods, A and B, with good A on the horizontal axis, draw a well labeled graph to show the substitution and income effects for good A, following an increase in the price of A and where good A has a perfectly inelastic demand.

Label the income and substitution effects

6. Assume Jim is considering buying a lottery ticket with a 40% chance of winning \$20, and a 60% chance of winning \$100. Assume Jim is risk averse. Using a well-drawn graph based on those used in class, illustrate the decision making situation faced by Jim and his preferences over this gamble. Be sure your graph includes a depiction of Jim’s expected utility from the gamble, the expected value of the gamble, and Jim’s limit price (MWP) for buying this ticket.

7. In terms of “direction of the effect,” Inferior goods goods have an income effect that is  related to a price change and a substitution effect that is related to a price change. Measured in terms of marginal utilities, the MRSAforB must equal.

Measured in terms of prices, at the bundle of goods that maximize utility, the MRSAforB must equal

The expected value of a gamble with two outcomes (O1 with probability P1 and O2 with probability P2) is equal to ________________________________. A person who is risk averse would have a limit price (maximum willingness to pay) for this gamble the expected value.

8.  As shown in class, draw the intertemporal budget line faced by a consumer who has income Y1 in year 1 and income Y2 in year 2. Further, assume the consumer can earn an interest rate of “r” on savings or pay an interest rate of “r” on borrowing. Specifically denote the choice combination where the person does not save or borrow.