05 Jun Question Question 1 [10 points total]
Question
Question 1 [10 points total]
Below each statement, write whether the statement is true or false.
a) If the demand curve is a downward-sloping straight line, then the price elasticity of
demand is constant all along the demand curve. [2 points]
b) It is possible to have decreasing marginal products for all inputs, and yet have increasing
returns to scale. [2 points]
c) If there are increasing returns to scale, then costs per unit of output decrease as you move
downward and to the right along an isocost line. [2 points]
d) Average cost can never rise while marginal costs are declining. [2 points]
e) A Stackelberg leader will necessarily make at least as much profit as he would if he acted
as a Cournot oligopolist. [2 points]
Question 2: [20 points total] Recall Janis from our midterms. She realized that skipping lunch
to be able to buy cigarettes is affecting her performance in school. Janiss preferences changed,
and now she eats exactly nine sandwiches for every pack of cigarettes that she smokes. Janiss
allowance is $100 per month.
a) Use the graph 1 space to represent Janiss preferences, with packs of cigarettes on the
horizontal axis and sandwiches on the vertical axis, by drawing indifference curves that
pass through bundles (3,4), (2,16), and (15,8). [2 points]
1
Space for graph 1
Space for graph 2
2
b) If we label packs of cigarettes as 1 and sandwiches as 2 , write down a utility function
that represents Janiss preferences. Is this function unique? Explain your answer. [2
points]
c) If the price of sandwiches is $5 per sandwich and the price of cigarettes is $5 per pack,
how many sandwiches and how many packs of cigarettes will Janis consume per month if
her allowance is her only source of income and she spends her whole allowance on
cigarettes and sandwiches? (Show your work.) Show Janiss consumption choice on the
graph you drew in part a). [4 points]
d) What is the economic term (name) for the principle you used to derive Janiss
consumption choice? Describe this principle briefly. [2 points]
e) Draw another graph (let us call this graph 2) with 1 on the horizontal axis and 1 on the
vertical axis and show the point that represents Janiss quantity of cigarettes demanded
when the price is $5 per pack. [2 points]
f) Suppose that the government wants to discourage teenage smoking by raising the price of
cigarettes to $21.66 per pack. What is the new optimal quantity of cigarettes consumed
3
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