Ch 4 Practice Problem Set
1. Consider the following:
(i) Can a good have both a downward-sloping Engel curve and a downward-sloping demand
curve? Why or why not?
(ii) Can a good have both an upward-sloping Engel curve and an upward-sloping demand
curve? Why or why not?
2. Suppose the demand curve for bus travel is downward sloping, and the income elasticity of demand for
bus travel is negative.
(i) Design an indifference curve-budget line diagram showing the substitution and income
effects created when the price of bus travel falls. In your diagram, place bus travel on the
horizontal axis and all other goods on the vertical axis.
(ii) How you can tell from your diagram that the income elasticity of demand for bus travel
is negative? Explain.
3. Suppose that the local utility regulators have recently approved an increase in the price of electricity from
10¢ per kilowatt-hour to 10.5¢ per kilowatt-hour. The long-run price elasticity of demand for electricity is
estimated to be -1.2.
(i) By how much will the quantity demanded of electricity drop in the long run because of
this price increase?
(ii) When the price of electricity increases, will consumers' total expenditures on electricity
rise or fall in the long run? (Hint-Consider which is larger, the percentage increase in
price or the percentage decrease in quantity demanded.)
(iii) The cross elasticity of demand for electricity with respect to natural gas is 0.2. By how
much would the price of natural gas have to change to totally offset the effect that the
price increase in electricity has on the quantity of electricity consumed? In other words,
by how much would the price of natural gas have to change to cancel out the fall in the
quantity demanded that you calculated in part i?
4. Assume that there are only two good for a consumer to purchase. Explain why a consumer cannot be
maximizing utility if both goods are inferior.
5. a. Suppose you consume shoes and chocolate. Say your income is $120, the price of shoes is $4 and the
price of the chocolate is $3. Draw the budget constraint below. (Show the slopes and end points for the
graphs.)
b. Suppose your optimal choice of consumption is 10 pairs of shoes. How many packs of chocolate do
you consume? (As usual, you don’t save.) Draw an appropriate utility maximizing indifference curve
below.
b. Now let the price of shoes drop to $2. Assuming shoes are a normal good for you, draw in the new
utility maximizing bundle (you no longer necessarily buy 10 pairs of shoes). Using the graph above to
illustrate your answer, verbally define and explain income and substitution effects and how they conspire
to make up the change in your quantity demanded of Shoes.
c. Based on your diagram, is chocolate (the good on the y-axis) a normal or an inferior good? Are shoes
and chocolate substitutes or complements? Explain.
d. Explain how your graph in part ‘b’ above would have been different if you thought of shoes as a Giffen
Good.
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