Exam (elaborations)
Antwoorden Tentamen Economie (8 juli 2005)
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Answers exam Economics, July 8, 20051a. 1d.
- Completeness: consumers are able to rank bundles of goods according to The optimal consumption bundle satisfies two conditions:
satisfaction or utility. (i) it is on the budgetline
- Non-satiation: more is better. A higher amount of a good leads to more (ii) MRS = slope budget line
satisfaction. Ad (i) The budget line is 10qc + 5qw = 40.
- Decreasing MRS: the more you have a one good relative to another, the more you If we put wine on the vertical axis, we can write: qw = -2qc + 8
are willing to give up of it to obtain more of the other, such that utility remains Ad (ii) We have MRS = -MUc/MUw
constant. So MUc = 6qw and MUw = 6qc and MRS = - qw/qc
qw/qc = 2 ↔ qw = 2qc
1b. Assume we have two goods A and B. Fill into the budget constraint: 10qc + 5qw = 10qc + 10qc = 20 qc = 40 → qc = 2 → qw = 4.
- Complements: if the price of good A rises, the demand for good B falls.
- Substitutes: if the price of good A rises, the demand for good B increases. 2a. There is a difference between short run and long run:
- short run: individual supply curve is marginal cost above the average variable
1c. costs: p = MC and p > AVC.
Short answer: the substitution effect dominates the income effect if two goods are - Long run: individual supply curve is marginal cost above average costs: p = MC
substitutes. and p > AC.
Why?
Explanation: - Why marginal costs? Suppose a firm want to supply an additional unit. The
The impact of a price increase can always be decomposed into two effects: (i) the minimum amount that the firm want to earn is the cost of that additional unit, and
substitution effect (measures the impact of a change in the relative price, keeping utility the cost of the additional unit is, by definition, the marginal cost.
constant) (ii) the income effect (measures the impact of the decrease in real income). - Why above AC in long run? AC indicates the cost per unit and the price indicates
If we have two goods A and B that are substitutes, the consumption of good B increases the revenues per unit. So if p >= AC no loss is incurred. In the long run, firms
if the price of good A increases (= total effect). Substitution effect: if the price of good A cannot survive if they make losses.
increases, the substitution effect is positive for good B and negative for good A. The - Why p > AVC in short run? Not that this does not preclude losses in the short run.
income effect can be positive or negative depending on whether the good is inferior or But in the short run, the firm wants to cover at least its variable (avoidable) costs,
normal, respectively. Thus, if goods A and B are substitutes, either good B is inferior such that it can cover at least part of its fixed (unavoidable in the short run) costs.
such that both the substitution effect and the income effect are positive, or good B is
normal and the positive substitution effect dominates the negative income effect, such 2b.
that the total effect is positive. (i) The marginal cost of production may change (= change of price of input
factors): the individual supply curves shift upward if the marginal cost
increase, and therefore the market supply curve shifts upward. The impact on
the market equilibrium is an increase in the price and a decrease in the
quantity.
(ii) The number of firms in the market may change: if the number of firms
increases, the market supply curve shifts to the right, as the market supply
1 2
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