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Economics 4351 assignment

Problem 1 (15 points; 5 points per part) Please define or explain the following terms. A complete answer will include a graph, equation, and/or example as part of each definition.

  1. Consumer surplus
  2. Giffen good
  3. Income elasticity of demand

Problem 2 (10 points) Yao’s weekly demand for basketballs is given by Qd = 3 − P2 where P is the price of basketballs. At the current price, Yao’s demand for basketballs is unit elastic. What is the current price of a basketball, and how many basketballs is Yao buying at this price?

Problem 3 (20 points) Each day Akiko, who is in third grade, eats lunch at school.

She likes only Twinkies (t) and soda (s), and these provide her with utility of

U(t,s) = t3 · s − 3

Twinkies cost $0.15 each and soda costs $0.30 per cup at the school cafeteria. Akiko’s parents give her $1.20 each day for lunch.

  1. Find the marginal utility of Twinkies (MUt) and marginal utility of soda (MUs) if Akiko buys t Twinkies and s sodas.
  2. What two equations must hold at the bundle (t,s) that maximizes Akiko’s utility? Solve for her optimal combination of Twinkies and sodas.
  3. The school is considering several possible policies to curb Twinkie consumption. Among the policies being considered are (1) limiting students to one Twinkie per day; and (2) raising the price of Twinkies to $45 each. The PTA (Parent-Teacher Association) has hired you to guide its decision. Discuss the expected effects of these two policies, using graphs and/or equations, as appropriate. (You may assume that all students have preferences identical to Akiko’s.) Which policy will you recommend?

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This page intentionally left blank. Use it as needed for problem 3.

Problem 4 (20 points) Jacques gets utility from atoms and molecules. Last week, Jacques had a weekly income of $150, and the price of atoms was $12. Jacques consumed seven atoms and eleven molecules. This week, the price of a molecule is $10; Jacques’s income and the price of atoms are unchanged. Suppose Jacques consumes six molecules this week.

  1. Indicate both budget constraints and both bundles on a well-labeled graph, with atomson the x-axis.
  2. Is Jacques better off or worse off this week relative to last week? Explain.
  3. Are atoms and molecules complements or substitutes for Jacques? Explain.
  4. Next week, prices are expected to be the same as this week, but Jacques’s incomeis expected to increase to $ Add this future budget constraint to your graph. Relative to last week, will Jacques be better off next week, worse off, or can’t you tell? Explain.

Problem 5 (10 points) After observing Olga’s consumption choices for two days in a row, Pavel, an economics student, tells here: “You must not be rational. Yesterday, when bananas were on sale for $1 and peaches were $5, you bought five bananas and one peach. Today, bananas are back to $2 and peaches are still $5, and you’re still buying five bananas!”

  1. Show graphically Olga’s budget constraint and chosen bundle from yesterday.
  2. Are there any explanations other than irrationality that are consistent with Olga’sbehavior? Use words, diagrams, and equations in your answer.
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