EC 203 PS: CH 10FALL 2005
1.If apples today are perfect substitutes for bananas today, then apples today must also be perfect substitutes for bananas tomorrow. FALSE
2.Alper is a net borrower when the interest rate is 10% and a net saver when the interest rate is 20%. A decrease in the interest rate from 20 to 10% may make Alper worse off.TRUE
3.Derin's utility function isU = min {a1, a2} min {b1, b2}, where a1 and a2 are the number of piano lessons he consumes this year and next and b1 and b2 are the number of ice skating lessons he consumes this year and next. The price of piano lessons is $10 each and the price of ice skating lessons is $4 each. The prices won't change, but the interest rate is 7%. If Derin consumes 20 piano lessons this year, how many ice-skating lessons will he consume next year?
a) 50
b) 20
c)40
d) 30
e) There is not enough information to be able to tell. A
5.In an isolated peasant village, the only crop is corn. Good harvests alternate with bad harvests. This year the harvest will be 1,000 bushels. Next year it will be 150 bushels. There is no trade with the outside world. Corn can be stored, but rats will eat 25% of what is stored in a year. The villagers have the Cobb-Douglas utility function U(c1, c2) = c1, c2, where c1 is consumption this year and c2 is consumption next year.
a. Draw a budget line for the village with this year's consumption on the horizontal axis and next year's consumption on the vertical axis. On your graph show the quantities at which the budget line intercepts the vertical and horizontal axes.
b. How much will the villagers consume this year?
c. How much will the rats eat?
d. How much will the villagers consume next year?
b. 600 bushels. c. 100 bushels. d. 450 bushels.
6.Harun is a chicken farmer. His earnings will be $100 this year and $100 next year. He can lend money at an interest rate of 20%. Because of a subsidized loan program for chicken farmers, he can borrow money at an interest rate of 10%. No matter what he borrows or lends, his earnings will still be $100 each year.
a. If he is not allowed to either borrow or lend, draw a graph showing his budget between
consumption this year and consumption next year. Put numerical labels on the vertical and horizontal intercepts of the budget set.
b. Suppose that Harun is allowed to borrow up to the present value of next year's earnings at 10% and is also allowed to make loans. Draw Harun's budget constraint in this case.
a. His budget line is kinked at (100, 100). The vertical intercept is 220. The horizontal intercept is 100 + 100/1.1.
b. His budget constraint is a straight line with slope -1.2 passing through the horizontal intercept of his previous budget line.
7. Keremlives in a farm. He works 80 hours a week. He can either grow A or raise B. Every hour that he spends growing A gives him $2 of income this year. Every hour that he spends raising B this year will add $4 to his income next year. In fact, next year's weekly income will be 100 + 4H dollars where H is the number of hours he spends raising B this year. Kerem's utility function is U(c1, c2) = min {c1, c2}, where c1 and c2 are his consumption expenditures this year and next year. Kerem doesn't believe in banks and will neither lend money nor borrow money.
a. Draw Kerem's budget line for current and future consumption, labeling key points on it.
b. Howmany hours a week will he choose to spend raising B?
c. How much money will he spend per week on consumption in each year?
a. His budget set is bounded by a line from (0, 420) to (160, 100) and a vertical line from (160, 100) to the horizontal axis.
b. 10.
c. 170.
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