David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

Review questions
• The market demand curve is the horizontal sum of individual demand curves, at each price adding
together the individual quantities demanded.
• Consumers prefer to receive transfers in cash rather than in kind, if the two transfers have the same
monetary value. A transfer in kind may restrict the choices a consumer can make.
Review questions
connect
A consumer's income is £50. Food costs £5 per unit and films cost £2 per unit. (a) Draw the budget
line. Pick a point e as the chosen initial consumption bundle. (b) The price of food falls to £2.50.
Draw the new budget line. What can be said about the new consumption point e' if both goods are
normal? ( c) The price of films also falls to £ 1. Draw the new budget line and show the chosen point
e ' . (d) How does e ' differ from e? Why?
2 The own-price elasticity of demand for food is negative. The demand for food is inelastic. A higher
food price raises spending on food. Higher food prices imply less is spent on all other goods. The
quantity demanded of each of these other goods falls. Discuss each statement. Are they all
correct?
3 Suppose films are normal goods but transport is an inferior good. How do the quantities demanded
for the two goods change when income increases? Draw the old and new budget lines and illustrate
the change in demand.
4 Suppose Glaswegians have a given income and like weekend trips to the Highlands, a three-hour
drive. (a) If the price of petrol doubles, what is the effect on the demand for trips to the Highlands?
Discuss both income and substitution effects. (b) Use a demand and supply diagram to show what
happens to the price of Highland hotel rooms.
5 True or false On a given indifference curve, the marginal rate of substitution is always decreasing.
6 Common fallacies Why are these statements wrong? (a) Since consumers do not know about
indifference curves or budget lines, they cannot choose the point on the budget line tangent to the
highest possible indifference curve. (b) Inflation must reduce demand since prices are higher and
goods are more expensive.
7 Frank derives utility from two goods, X and Y, that is given by U = XY. Find the indifference curves
of Frank, when utility is 10, 20 and 30. Plot those indifference curves. How should Frank compare
the following two bundles: (X = 1, Y = 10) and (X = 5, Y = 2)?
8 Suppose that Frank has an income of £50, the unit price of X is Px = £2 and the unit price of Y is
py = £ 1. Write down the budget constraint for Frank. Knowing that the marginal rate of substitution
(in absolute value) between X and Y is MRS = X/Y, find the optimal bundle that Frank should
consume. (Hint: in the optimal bundle the absolute value of the MRS must be equal to the absolute
value of the slope of the budget constraint. Moreover, the budget constraint must be satisfied. You
need to solve a system of two equations in two variables, X and Y.)
9 Consider a consumer who consumes only two goods: peas and beans. She has an income of £10,
the price of beans is 20p ( = £0.2) while the price of peas is 40p ( = £0.4).
117