Eco 301 Name_______________________________
Test 1 17 June 2005
100 points. Allocate your time efficiently.
1. Suppose that Samantha and Jason both spend $24 per week on video and movie entertainment.
When the prices of videos and movies are both $4, they both rent 3 videos and buy 3 movie tickets.
Following a video price war and an increased cost of movie tickets, the video price falls to $2 and
the movie ticket increases to $6. Samantha now rents 6 videos and buys 2 movie tickets; Jason,
however, buys 1 movie ticket and rents 9 videos.
a. Is Samantha better off or worse off after the price change?
b. Is Jason better off or worse off?
Both are better off because they have reached higher indifference curves. This is always the case
following a change in relative prices that still lets the consumer chose the original optimum bundle.
2. Suppose the demand curve for computers is downward sloping, and the income elasticity of
demand for computers is positive.
(a) Design an indifference curve-budget line diagram showing the substitution and
income effects created when the price of a computer falls. In your diagram, place
computers on the horizontal axis and all other goods on the vertical axis.
(b) How you can tell from your diagram that the income elasticity of demand for
computers is positive? Explain.
3. Use the consumer choice model (indifference curves and budget lines) to derive a demand
curve for coke. (Hint: It is probably easier to start with a high price for coke, then lower the
price. Try to do this neatly.)
4. The food stamp program provides low-income households with coupons that can be
exchanged for some specified dollar value worth of food. Many economists argue that this
program is an inefficient means of increasing the well being of low-income families. Proponents
of this view argue that an equivalent cash subsidy would bring about a greater increase in the
well being of families receiving aid. Although many economists hold this view, not all policy
analysts agree with the advocates of cash payments instead of food stamps. Advocates of the
existing program argue that food stamps provide an incentive for low-income families to
increase the nutritional quality of their diets.
a. Carefully analyze the arguments regarding increases in well being under cash payments and
food stamp programs. Use graphical analysis to present your arguments.
b. Do food stamps insure that low-income families increase their consumption of food?
