Microeconomics, indifference curves, final exam practice problems

(The attached PDF file has better formatting.)

*Question 1.1: Indifference Curves

An economy has only two goods: bread and wine.

! Points jN and jNN lie on indifference curve J.

! Points kN and kNN lie on indifference curve K.

jN = 5 bread and 2 wine

jNN = 3 bread and 6 wine

kN = 6 bread and 4 wine

Which of the following cannot be the value of kNN?

A. 2 bread and 5 wine

B. 1 bread and 9 wine
C. 0 bread and 15 wine
D. 8 bread and 1 wine
E. 15 bread and 0 wine

Answer 1.1: A

kN is more valuable than jN, since it has more bread and more wine. kNN has the same value
as kN, and jNN has the same value as jN, so kNN must be more valuable than jNN.

In Choice A, kNN has less bread and less wine than jNN, so it can not be more valuable.

*Question 1.2: Indifference Curves

Which of the following is the same for all points on an indifference curve for food and
clothing?

A. The relative satisfaction for food vs clothing in each basket.

B. The total satisfaction obtained from consumption of the food and clothing in each
basket.
C. The consumer’s total spending on food and clothing .
D. The relative prices for food vs clothing in each basket.
E. The total price of food and clothing in each basket.

Answer 1.2: B
Statement A: If one point on an indifference curve has more food that a second point, the
second point has more clothing.

! The relative satisfaction of total food is greater for the point with more food.
! The relative satisfaction per unit of food is greater for the point with less food, by the
law of decreasing marginal utility.

Statement B: An indifference curve means the consumer is indifferent between any two
points on the curve.

Statements C, D, E: Spending and prices depend on the budget line, not the indifference
curve.

*Question 1.3: Properties of Indifference Curves

Which of the following is not a property of indifference curves representing a consumer’s

tastes between food and clothing, both of which are economic goods?

A. A given basket of food and clothing cannot be on more than one indifference curve.
B. No two indifference curves for the same consumer can cross.
C. The indifference curves are parallel (though not necessarily straight lines).
D. The indifference curves are downward sloping.
E. The indifference curves reflect the marginal utility of food in terms of clothing.

Answer 1.3: C

Statements A and B: Different indifference curves have different utilities, so

! They cannot cross.

! No basket of goods can be on more than one indifference curve.

Statement C: Indifference curves are not parallel, though they may seem parallel in the
graphs.

Statement D: Indifference curves are downward sloping because of decreasing marginal

utility. As the amount of food (or clothing) increases, each additional unit of food (or
clothing) is less valuable to the consumer.

Statement E: The marginal utility of one good in terms of the other is the negative of the
slope of the indifference curve.

Jacob: What does it mean that two curves are parallel? Doesn’t the term parallel refer to
straight lines, not to curves?
Rachel: Parallel means the slopes are the same, though the slopes of each curve may
change. Two curves are parallel is one is an additive displacement of the other. If we
move the X values " units to the right or left and the Y values $ units up or down, the two
curves are parallel.

Jacob: Can you give an example?

Rachel: Suppose one curve is xy – 16 = 0. A displacement of the curve might be

(x – 1)(y – 1) – 16 = 0 A xy – x – y – 15 = 0

*Question 1.4: Optimizing Welfare

A consumer spends all his income on bread and wine, buying 80 loaves of bread and 80
flasks of wine. Bread costs $2 a loaf and wine costs $8 a flask. Both bread and wine are
sold in competitive markets. The marginal value to the consumer of a flask of wine is 5
loaves of bread. Which of the following is most likely to be true?

A. The consumer would be better off if he purchased 100 flasks of wine and no bread.
B. The consumer would be better off if he purchased 400 loaves of bread and no wine.
C. The consumer would be better off if he purchased 81 flasks of wine and 76 loaves of
bread.
D. The consumer would be better off if he purchased 79 flasks of wine and 84 loaves of
bread.
E. Since bread and wine are sold in competitive markets, no other purchase can make the
consumer better off.

Answer 1.4: C

*Question 1.5: Constant Marginal Value

If the consumer’s marginal value is constant, then

A. There is no optimum purchase for the consumer.

B. The consumer’s indifference curves are concave instead of convex.
C. The consumer’s indifference curves are straight lines.
D. The possibility of corner solutions is eliminated.
E. Utility maximization occurs anywhere along the budget line.

Answer 1.5: C
Suppose the marginal value of a flask of wine is four loaves of bread and the consumer
has $100.

! If the price is $2 for a loaf of bread and $10 for a flask of wine, the consumer buys 50
loaves of bread and no wine (corner solution).
! If the price is $2 for a loaf of bread and $5 for a flask of wine, the consumer buys 20
flasks of wine and no bread (corner solution).
! If the price is $2 for a loaf of bread and $8 for a flask of wine, any combination of bread
and wine gives the same utility (statement E).

*Question 1.6: Marginal Value

If Jacob’s marginal value of bread is 50¢ per loaf, then

A. Jacob places a value of 50¢ on his last loaf of bread.

B. Jacob will not buy any bread unless the price is lower than 50¢ per loaf.
C. Jacob is willing to pay an average of 50¢ per loaf of bread.
D. Jacob is willing to trade away all his bread in exchange for 50¢ per loaf.
E. Jacob’s utility increases by 50¢ when he buys a loaf of bread.

Answer 1.6: A

*Question 1.7: Indifference curves and Consumer’s Optimum

For two economic bads that are harmful, such as air pollution and water pollution, or a jail
term and a monetary fine, the consumer’s indifference curves are downward sloping and
concave (bowed away from the origin) instead of convex. What can be said about the
consumer’s optimum?

A. The consumer’s optimum is always a corner solution in this situation.

B. The consumer’s optimum does not exist, because there is no tangency in this situation.
C. The consumer’s optimum is at the tangency between the indifference curve and the
budget line, and the indifference curve lies below the budget line.
D. The consumer’s optimum is at the tangency between the indifference curve and the
budget line, and the indifference curve lies above the budget line.
E. The consumer has two optima: one at the tangency and one at a corner solution.

Answer 1.7: C

Jacob: How can the indifference curves be concave?

Rachel: If two items are desired by the consumer, the indifference curves are convex. If
two items are harmful to the consumer, the indifference curves may be concave.
Illustration: Suppose a consumer must pay a fine and serve time in jail. The consumer
may be indifferent among the following choices:

~ 20 years in jail and a $100,000 fine

~ 15 years in jail and a $150,000 fine
~ 10 years in jail and a $200,000 fine

These choices form a straight line. If the consumer doesn’t like jail or fines, he or she may
be indifferent among the following choices:

~ 20 years in jail and a $100,000 fine

~ 15 years in jail and a $150,000 fine
~ 10 years in jail and a $200,000 fine

*Question 1.8: Indifference Curves and Budget Lines

All but which of the following are true regarding indifference curves and budget lines?
Assume that the consumer’s optimum is not a corner solution.

A. The equation of the budget line is X × Px + Y × Py = Income.

B. The indifference curve reflects consumers’ preferences; the budget line reflects what
they can afford to buy.
C. The slope of the budget line is –Px / Py.
D. At the consumer’s optimum, the slope of the indifference curve is –Px / Py.
E. If the prices of all goods rises 20%, the optimal point does not change.

Answer 1.8: E

Statement E: If the prices of all goods rises 20% and income also rises 20%, the optimal
point does not change. If income does not rise, the budget line moves inward. The
indifference curves are not parallel, so the absolute and relative amounts of each good
change.

Illustration: A consumer has income of $1,000 and spends $800 on food and $200 on
movies. If all price rise by 20% and the consumer’s income does not change, the food
costs $960 and the movies cost $240. The consumer might spend $950 on food (eating
a bit less) and only $50 on movies (which are a luxury).

*Exercise 1.9: Marginal Value

(T/F) If the marginal value of X in terms of Y is greater in absolute value than –Px ÷ Py, the
consumer would be better off buying less X and more Y.

Solution 1.9: False. The consumer would be better off buying more X and less Y.
This situation is a point like A, where the indifference curve is steeper than the budget line.
The consumer would be better off at point B, where more X is consumed and less Y.

At point A, the consumer would trade more units of Y for 1 unit of X than the market
requires. For example, the consumer may be willing to give up 3 units of Y to get 1 extra
unit of X, so the marginal value of X in terms of Y is 3. By contrast, the price of X may be
$3 and the price of Y may be $1.50, so the slope of the budget line is –2. The consumer
is willing to give up 3 units of Y for a unit of X, but finds that he only has to give up 2 units
of Y to buy an extra unit of X. The consumer is better off buying more X and less Y, until
the rate at which he is willing to trade the 2 goods equals the rate at which he must trade
them in the market.

*Question 1.10: Utility Functions

If a consumer’s utility function is represented by U(x, y), all but which of the following are
true?

A. An indifference curve is represented by U(x, y) = C, where C is a constant (the locus

of points x,y that offer the same utility to the consumer).
B. The marginal utility of X is represented by MU/MX (not considering the price paid for the
good).
C. The marginal value of X in terms of Y is MUx/MUy (the change in the value of good X
in terms of the change in the value of good Y).
D. The consumer optimum is where MUx/Px = MUy/Py (the marginal value of both goods
is equal in terms of the price paid for each good).
E. MY/MX = K, where K is a constant (the slope of the utility function is constant).

Answer 1.10: E
Statement A is true. An indifference curve shows a set of baskets of goods among which
the consumer is indifferent, meaning that each basket gives the consumer the same utility.
Setting the utility function equal to a constant provides the equation for an indifference
curve.

Statement B is true. Marginal utility is the amount of additional utility derived from an
additional unit of X, when the quantity of Y is held constant. This is a partial derivative.

Statement C is true.

Statement D is true. To maximize utility, the consumer must get as much utility from the
last dollar spent on X as from the last dollar spent on Y. Were this not the case, utility
could be increased by switching the last dollar from the the good that provides less utility
to the good that provides more utility. At the consumer optimum, the ratio of the marginal
utility of the good to its price must be the same for both goods.

*Question 1.11: Corner Solutions

Suppose bread is on the horizontal axis and wine is on the vertical axis. Consider a corner
solution in which the consumer buys only wine and no bread. At this optimum, the relative
price of bread in terms of wine

A. Is strictly less than the marginal value of bread in terms of wine.

B. Is less than or equal to the marginal value of bread in terms of wine.
C. Is equal to the marginal value of bread in terms of wine.
D. Is greater than or equal to the marginal value of bread in terms of wine.
E. Is strictly greater than the marginal value of bread in terms of wine.

Answer 1.11: D

The budget line can be steeper than the indifference curve at a corner solution.