ECON 320_ Actual Midterm

.docx

School

Pepperdine University *

*We aren’t endorsed by this school

Course

320

Subject

Economics

Date

Apr 3, 2024

Type

docx

Pages

Uploaded by JudgeSalamanderPerson652

1. "A commodity with a market price of zero is worthless. Therefore, the commodity's total market valuation is also zero." Carefully explain the fallacy in this statement. When a good is “free” it means that the consumer may consume as many units without having to sacrifice something of value. So long as the market is at competitive equilibrium, thus the price of this “free good” is 0. Any rational person would consume as many units of this free good where their marginal value of the good is zero. Meaning, a person will consume the “free good” up to where the maximum amount they’re willing to give up to obtain the last unit is jsut equal to wha they have to give up to obtain that last unit, which is nothing, thus meaning zero. So, in terms of marginal valuation, the last unity of good consume ies effectively worthless, while the earlier units consumed are not worthless. That is, the total value of the free good can be positive while the marginal value of the last unit consumed is zero. There’s a clear distinction between marginal valuation and total valuation, demand may not be up for this certain good, but the market value doesn’t always reflect the total value it gives to people. 2. At prevailing prices, an individual with standard preferences purchases 15 units of commodity x. Will he be indifferent between a $2 per unit subsidy on the consumption of x and a $30 increase in his income? Carefully demonstrate and explain. (Assume two goods, x and y.) In this case, the $2 per unit subsidy rotates the individuals budget constraints changing the original consumption optimum (from point one to point 2) The $30 income increase will completely shift the individuals budget constraint to the right, and this BC passes through point 2. Both scenarios allow for more consumption of good Y with X remaining at 15 units. However, depending on whether if X is an inferior good or not will determine what the individual prefers. If X is an inferior good, the individual would prefer the $30 income increase, which would allow him to reach higher indifference curve in comparison to the $2 subsidy . But, if X is a normal good, the individual would prefer the $2 subsidy, where the consumer would still reach a higher indifference curve in comparison to his “pre subsidy” position. 3. "If there is a competitive market-clearing price in the market for a particular good, then the existing supply of the good is allocated so that its total value is maximized. If the typical rich person purchases more of the good than a typical poor person in this competitive equilibrium, then the rich person will have a higher marginal valuation (or MRS) for the good than the poor person." Is this statement correct? Carefully explain your reasoning why or why not. Both of these statements are incorrect. The marketing clearing price, aka equilibrium, means that quantity demanded = quantity supplied. This is done so that there is no excess supply and in order for that to happen consumer surplus and producer surplus are maximized. The market is efficient with allocation in the way that these two sums (consumer surplus and producer surplus) are maximized, but this alone does not guarantee that total value is maximized. Now, at the equilibrium price all buyers, rich or poor, face the same price. Under the assumption that any consumer will act rationally, they will purchase additional units of the good as long as the marginal value of the good is greater than the price(cost for the consumer). Because the rich and poor person is facing the same price, their individual marginal valuations become equated in a competitive equilibrium. Therefore, rich or poor they will continue to buy to increase their utility. Their MRs do not differ in this case, but perhaps their total valuation for the good might. The statement is false.

4. When the price of gasoline is $2 per gallon, John purchases 1,000 gallons per vear. If the price rises to $2.50 per gallon, assume the government offsets the harm to John giving him a cash transfer of $500. Will John be better or worse off after the price rise plus the transfer? How will his gasoline consumption be affected? Assume there are two commodities, gasoline (G) and a composite good (C). Carefully demonstrate and explain. a. The increase in price of gasoline rotates his BC (income line) to the left because it causes him to be able to buy less Gas than before. However, the $500 increase income subsequently shifts his entire budget constraint to the right. This new BC passes through his original consumptive optimum before the increase in price of gas. The new BC passes through the entire preferred set of the original indifference curve, thus allowing John to not only be able to be place back into his original position, but rather he can actually reach a higher indifference curve considering the new BC passed through the strictly preferred set. The new indifference curve tangency lies in the strictly preferred set – he will be better off. b. Also, batch says he will consume less gasoline. 5. Suppose Congress is considering a child-care subsidy to aid poor families. There are two different subsidy programs being considered. One program is a specific subsidy that lowers the hourly price a poor family pays for child care. Alternatively, the government could provide an unrestricted lump-sum income supplement under the welfare program that could be spent on child care and units of a composite good (including food and housing). First, assuming the government expenditure per poor family would be the same under each policy, begin with the pre- subsidy budget constraint for a representative poor family and show how the specific subsidy would affect the family's budget constraint. Second, show the budget constraint for the lump-sum income subsidy (for the same amount of money). Third, which subsidy policy would a recipient family prefer? Which policy results in a greater increase in the demand for child-care services by a representative poor family? The subsidy lowers cost of child care, the BC rotates to the right because now the family can consume more of child care. This scheme ensures that the demand for child care services increases because cost has been reduced. Assuming Child Care is not a giffen good, then the representative consumer will consume more of good C thanks to the subsidy. The increase in income creates a parallel line and shifts the BC to the right. With the subsidy, only increase in consumption of C will occur. With the increase in income, the increase of consumption of other goods can occur. However, there’s no guarantee that the family will in fact consume more C with the increase income. They are better off with either scenario, but the income increase will allow the family to reach a higher indifference curve than the subsidy situation. 6. During the 2008-2009 financial crisis, the average person experienced a significant wealth loss. To understand the consequence of such a wealth loss on current consumption spending, consider a representative individual consumer who receives income today and income in the future, and owns financial assets today. Suppose the individual's income is $1,000 in each of two periods, and that the individual's pre-crisis assets are initially worth $10,000 in the first period. First, construct the pre-crisis intertemporal (income and wealth) endowment and show the budget constraint assuming a one-period interest rate of 10 percent (assume any income saved or wealth not spent in the initial period will grow by 10- percent into the future period). Show and explain the optimal combination of current and future income when the individual's preferences act to equalize the individual's consumption in each of the two periods. Second, suppose the individual's initial wealth declines to $5,000 when the financial crisis occurs (during the initial period) while the person's income is unchanged in each of the two periods. Show how this decrease in wealth affects

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version