Test Bank for Microeconomics and Behavior 9th

Edition Frank 0078021693 9780078021695

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Chapter 05

Applications of Rational Choice and Demand Theories

Multiple Choice Questions

1. If the government wanted to curb consumption of alcohol by taxing alcohol without hurting
consumer's welfare it would

A. raise the tax on alcohol until demand for alcohol became elastic.

B. need to know the substitution effect but not the income effect of a tax hike.

C. need to know the income effect but not the substitution effect of a tax hike.

D. tax until the income effect of the price increase, which would be refunded, is exactly equal
to the revenue gained from the tax.

5-1
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2. If an educational voucher system were adopted where parents could spend their share of
education tax dollars at any school of their choice, then we could expect families to

A. choose less education than before because the public schools would get better.

B. choose more education because they do not need to pay double for private education.

C. make no changes in their education choices because the relative price of private and
public education has not changed.

D. make choices that cannot be predicted by economic theory.

3. If I get 10 units of pleasure from my first ice cream cone and 2 less units than before from
each succeeding cone, I will buy ____ cones and gain _____ units of consumer surplus if the
price of a cone = to 5 units of pleasure.

A. 4; 28

B. 6; 30

C. 2; 18

D. 3; 9

4. If you buy food which then is put on special at half price just after you paid,

A. you will be disappointed and be worse off.

B. you will be better off because you will go back to get some more food at bargain prices.

C. your welfare will not change since you just finished your shopping.

D. logic cannot lead to an answer to this question even if you have a typical preference
pattern.

5-2
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McGraw-Hill Education.
5. The consumer price index overestimates inflation because it

A. compares prices of what consumers actually buy rather than a fixed basket of goods.

B. allows consumers to move along a given indifference curve from one year to the next.

C. measures the cost of a market basket in the second year that has too many units of the
most inflated items.

D. uses the second year's market basket as the base rather than the first year's basket.

6. The local golf course has upgraded seven of its 18 holes and raised its rates from 20 to 24
dollars. It would be correct to say that

A. the true inflation rate for golf is more than 20%.

B. the true inflation rate for golf is 20%.

C. the true inflation rate for golf is less than 20%.

D. more information is needed to answer this question.

7. If markets for addictive drugs have a more elastic demand curve than is often thought, and if
addicts tend to be unstable people with low incomes, we might speculate that the most likely
reason for the surprising elasticity estimates is that

A. the substitution effect is smaller than expected because addicts aren't as addicted as we
thought.

B. the income effect has a more constraining effect than we had anticipated.

C. addictive drugs are inferior goods.

D. the income and substitution effects work in opposite directions.

5-3
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8. If the opportunity cost of a unit of current consumption is exactly 1 unit of future
consumption then you must sacrifice $10 of current consumption to finance

A. $9 of future consumption.

B. $10 of future consumption.

C. $11 of future consumption.

D. $1 of future consumption.

9. Suppose a bank will pay you a 10% interest rate on your deposits for 1 period. In this case
you must sacrifice $10 of current consumption to finance

A. $9 of future consumption.

B. $10 of future consumption.

C. $11 of future consumption.

D. $1 of future consumption.

10. Suppose you receive Y1 of your income this period and Y2 of your income in the next period.
If you can either borrow or lend at an interest rate r, what is the most you can consume in the
future period?

A. Y1(1 + r) + Y2

B. Y2(1 + r) + Y1

C. Y1/(1 + r) + Y2

D. Y2/(1 + r) + Y1

5-4
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11. Suppose you receive Y1 of your income this period and Y2 of your income next period. If you
can either borrow or lend at an interest rate r, what is the most you can consume in the
current period?

A. Y1(1 + r) + Y2

B. Y2(1 + r) + Y1

C. Y1/(1 + r) + Y2

D. Y2/(1 + r) + Y1

12. The horizontal intercept of the intertemporal budget constraint is referred to as

A. the present value of lifetime income.

B. the current value of future income.

C. the future value of lifetime income.

D. the future value of present income.

13. If you wear your favorite clothes first and eat your favorite food before the food you prefer
less you most likely have a

A. positive time preference.

B. a negative time preference.

C. a neutral time preference.

D. time preference that varies depending on whether you are eating or dressing.

5-5
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14. If the marginal rate of substitution between future and current consumption is less than one,
then this consumer exhibits

A. a positive time preference.

B. a negative time preference.

C. a neutral time preference.

D. an increasing preference.

15. If $100 today is worth $150 to you in the future, then you exhibit

A. a positive time preference.

B. a negative time preference.

C. a neutral time preference.

D. a negative marginal rate of substitution.

16. A decrease in the interest rate will

A. produce an increase in current savings.

B. produce an increase in current consumption.

C. produce a decrease in current savings.

D. depend on the particular consumer's preferences.

17. The Permanent Income and Life-Cycle Hypothesis imply that

A. consumers generally favor current consumption over future consumption.

B. the primary determinant of current consumption is permanent income.

C. the primary determinant of permanent income is current consumption.

D. consumers are more likely to save if they are uncertain about the future.

5-6
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18. Differences in time preferences depend on

A. uncertainty regarding the future.

B. social preference.

C. differences in the relative size of expected future incomes.

D. the time.

19. When people choose to wait for a kiss that they have won from a favorite movie star, they are
clearly

A. exhibiting a negative time preference and anticipation value.

B. exhibiting a positive time preference with anticipation value.

C. exhibiting a zero time preference.

D. irrational by rational choice standards.

20. In general, most people

A. have a positive time preference.

B. have a negative time preference.

C. value the present and the future about the same.

D. have a negative time preference for food and basic necessities and a positive time
preference for services and luxuries.

5-7
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21. One thousand dollars given to you a year from now is worth __________ to you today if the
relevant discount rate is 10%.

A. $1,000

B. $1,100

C. $909

D. $900

22. In a diagram, consumer surplus is always represented by the area:

A. between the demand curve and the supply curve.

B. between the demand curve and the price.

C. below the demand curve.

D. above the demand curve.

23. If the demand function for apples is P = 1 - Q, how much consumer surplus does the
consumer gain when the price of the apples equals 5?

A. 25

B. 5

C. 20

D. 12.5

5-8
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24. In analyzing the gasoline tax and subsidy policy discussed in the text, the final solution
illustrates that

A. consumers are worse off than they were before the policy began.

B. consumers do not cut back on fuel consumption.

C. the government is made better off financially.

D. social welfare increases.

25. According to the analysis in your textbook, the school voucher program would

A. increase the level of spending on education.

B. decrease the level of spending on education.

C. leave the level of spending on education the same.

D. force some people to leave the public school system.

26. According to the analysis in your text, the school voucher program would

A. increase the quality of education.

B. decrease the quality of education.

C. not affect education quality, but would make lower income families better off.

D. increase the quality of education, but not improve the welfare of low income families.

5-9
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27. Colin's demand for golf at his local club each season is P = 50 - 2Q. If the golf course charges
$26 dollars per round of golf, how much could it charge Colin in a membership fee before he
would not play there?

A. $1,250

B. $144

C. $288

D. $312

28. If you had a windfall of $5,000 in the present time period and you save some of it, your saving
behavior would likely be due to the fact that

A. your marginal utility of present income falls as your income goes up.

B. the extra income changes the slope of your time preference indifference curves making
then steeper.

C. your indifference curves for present and future income are vertical.

D. your indifference curves for present and future are horizontal.

29. When a product depicted on the horizontal axis of a typical indifference curve model of
behavior is taxed

A. the budget line becomes steeper.

B. the budget line becomes flatter.

C. the indifference curve of the consumer shifts right.

D. all the indifference curves of the consumer become steeper.

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30. If the demand function for city bus rides is P = 100 - 10Q and the present price of a ride is 50,
then

A. raising prices will increase city revenue.

B. raising prices will decrease city revenue.

C. raising prices will not change city revenue.

D. from the information given it is not clear what would happen to city revenue if price is
increased.

31. Suppose your university decides to increase parking fees in order to deal with the shortage of
parking spaces. Nevertheless, the president of your student body convinces the university to
pay back the amount spent on higher parking fees to students in the form of a rebate at the
end of the school year. Therefore, the increase in parking fees will

A. not solve the parking shortage.

B. reduce demand for parking and hence alleviate the parking shortage.

C. will have no effect since it will be offset entirely by the rebate.

D. make the parking shortage even worse.

32. Say an individual demand curve was given by P = 50 - 5Q. When the price is $25, consumer
surplus is around

A. $63.

B. $188.

C. $125.

D. $100.

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33. Suppose an individual demand curve is given by P = 100 - 5Q, where P is the price of
smoothies and Q is the quantity she consumes. Assuming her income per week is $1,000 and
the current price of smoothies is $5 each, by how much will her consumer surplus decline if
the price of smoothies increased to $10 each?

A. $92.5

B. $810

C. $950

D. $25

34. Say the bus authority in your city increased the typical bus fare from $1.00 to $1.50 and that
due to this increase total revenue increased by 20%. Based on this we know that the price
elasticity of bus rides in your neighborhood is (assume demand curve is linear):

A. 0.4.

B. 0.8.

C. 1.

D. 1.5.

35. You have $20,000 of current income and $45,000 of future income. The interest rate between
the current and future period is 2 percent. What is the maximum amount you could consume
in the future?

A. 65,400

B. 69,000

C. 20,400

D. 65,000

5-12
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36. You have $20,000 of current income and $45,000 of future income. The interest rate between
the current and future period is 2 percent. When you allocate consumption optimally between
the two periods the marginal rate of time preference between the two periods is

A. -1.02.

B. -1.00.

C. -1.80.

D. 0.80.

37. According to the Life-cycle hypothesis, if a person received a payment roughly equals to her
current income her consumption would:

A. roughly double.

B. increase, but not by as much as the increase in income.

C. increase by more than the increase in income.

D. would not increase at all.

38. An interest rate increase to 4 percent will cause you to

A. save more of your income.

B. save less of your income.

C. be more time patient.

D. be more time impatient.

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39. Which of the following would be but best item for the local government to tax if its goal was
to raise revenue?

A. Water supply

B. Outdoor concert provided by the city

C. Weather reports on your phone

D. Leaf collection

40. If you get great pleasure from anticipating a fun event which of the following is true?

A. You have a higher marginal rate of time preference than if you didn't get that pleasure.

B. Your intertemporal indifference curve is steeper than it would be without that pleasure.

C. You likely have more savings than you would have without the anticipatory pleasure.

D. All of these are true.

41. Upon what is your current consumption dependent according to Milton Friedman?

A. The income you earn today.

B. The income you expect to earn later in life.

C. The present value of your lifetime income.

D. The future value of your present income.

5-14
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42. Budget A consists mostly of food, health care and an apartment and Budget B is made up
largely of Food, Entertainment, and Travel. If inflation is estimated by the consumer price
index which includes all the items listed above and travel and healthcare had the biggest
jump in prices, which of the following is true?

A. Budget A will likely have a less accurate estimate than budget B

B. Inflation will be equally biased for both budgets

C. Budget B will likely have a less accurate measurement than budget A

D. There should be no bias in this case because of the simple budget components

Essay Questions

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43. This graph below shows a consumer facing a choice between a cash gift or merchandise of
greater value.

Show, using a sketch graph, why a consumer prefers a cash gift rather than a larger gift of
merchandise.

44. Describe in words why the consumer price index overestimates inflation.

5-16
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45. The graphs below show an economy of two people with identical incomes in two years. They
have different preference patterns as shown.

Why is the market for loanable funds not in equilibrium?

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46. The graphs below show an economy of two people with identical incomes in two years. They
have different preference patterns as shown.

What will happen in the market to bring about equilibrium?

5-18
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 Chapter 05 Applications of Rational Choice and Demand Theories
Answer Key

Multiple Choice Questions

1. If the government wanted to curb consumption of alcohol by taxing alcohol without hurting
consumer's welfare it would

A. raise the tax on alcohol until demand for alcohol became elastic.

B. need to know the substitution effect but not the income effect of a tax hike.

C. need to know the income effect but not the substitution effect of a tax hike.

D. tax until the income effect of the price increase, which would be refunded, is exactly
equal to the revenue gained from the tax.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-04 Use price elasticity of demand to analyze the effects of changes in prices and taxes.
Topic: Using Price Elasticity of Demand

5-19
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
2. If an educational voucher system were adopted where parents could spend their share of
education tax dollars at any school of their choice, then we could expect families to

A. choose less education than before because the public schools would get better.

B. choose more education because they do not need to pay double for private education.

C. make no changes in their education choices because the relative price of private and
public education has not changed.

D. make choices that cannot be predicted by economic theory.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

3. If I get 10 units of pleasure from my first ice cream cone and 2 less units than before from
each succeeding cone, I will buy ____ cones and gain _____ units of consumer surplus if
the price of a cone = to 5 units of pleasure.

A. 4; 28

B. 6; 30

C. 2; 18

D. 3; 9

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-02 Use measures of consumer surplus to calculate the benefit from participation in specific
markets and design optimal two-part pricing schedules.
Topic: Consumer Surplus

5-20
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McGraw-Hill Education.
4. If you buy food which then is put on special at half price just after you paid,

A. you will be disappointed and be worse off.

B. you will be better off because you will go back to get some more food at bargain prices.

C. your welfare will not change since you just finished your shopping.

D. logic cannot lead to an answer to this question even if you have a typical preference
pattern.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

5. The consumer price index overestimates inflation because it

A. compares prices of what consumers actually buy rather than a fixed basket of goods.

B. allows consumers to move along a given indifference curve from one year to the next.

C. measures the cost of a market basket in the second year that has too many units of the
most inflated items.

D. uses the second year's market basket as the base rather than the first year's basket.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-03 Use the rational choice model to show how changes in prices and incomes affect consumer
well-being and identify one source of bias in the consumer price index.
Topic: Overall Welfare Comparisons

5-21
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McGraw-Hill Education.
6. The local golf course has upgraded seven of its 18 holes and raised its rates from 20 to 24
dollars. It would be correct to say that

A. the true inflation rate for golf is more than 20%.

B. the true inflation rate for golf is 20%.

C. the true inflation rate for golf is less than 20%.

D. more information is needed to answer this question.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-03 Use the rational choice model to show how changes in prices and incomes affect consumer
well-being and identify one source of bias in the consumer price index.
Topic: Overall Welfare Comparisons

7. If markets for addictive drugs have a more elastic demand curve than is often thought, and
if addicts tend to be unstable people with low incomes, we might speculate that the most
likely reason for the surprising elasticity estimates is that

A. the substitution effect is smaller than expected because addicts aren't as addicted as
we thought.

B. the income effect has a more constraining effect than we had anticipated.

C. addictive drugs are inferior goods.

D. the income and substitution effects work in opposite directions.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-04 Use price elasticity of demand to analyze the effects of changes in prices and taxes.
Topic: Using Price Elasticity of Demand

5-22
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McGraw-Hill Education.
8. If the opportunity cost of a unit of current consumption is exactly 1 unit of future
consumption then you must sacrifice $10 of current consumption to finance

A. $9 of future consumption.

B. $10 of future consumption.

C. $11 of future consumption.

D. $1 of future consumption.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

9. Suppose a bank will pay you a 10% interest rate on your deposits for 1 period. In this case
you must sacrifice $10 of current consumption to finance

A. $9 of future consumption.

B. $10 of future consumption.

C. $11 of future consumption.

D. $1 of future consumption.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-23
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McGraw-Hill Education.
10. Suppose you receive Y1 of your income this period and Y2 of your income in the next
period. If you can either borrow or lend at an interest rate r, what is the most you can
consume in the future period?

A. Y1(1 + r) + Y2

B. Y2(1 + r) + Y1

C. Y1/(1 + r) + Y2

D. Y2/(1 + r) + Y1

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

11. Suppose you receive Y1 of your income this period and Y2 of your income next period. If
you can either borrow or lend at an interest rate r, what is the most you can consume in
the current period?

A. Y1(1 + r) + Y2

B. Y2(1 + r) + Y1

C. Y1/(1 + r) + Y2

D. Y2/(1 + r) + Y1

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-24
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McGraw-Hill Education.
12. The horizontal intercept of the intertemporal budget constraint is referred to as

A. the present value of lifetime income.

B. the current value of future income.

C. the future value of lifetime income.

D. the future value of present income.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

13. If you wear your favorite clothes first and eat your favorite food before the food you prefer
less you most likely have a

A. positive time preference.

B. a negative time preference.

C. a neutral time preference.

D. time preference that varies depending on whether you are eating or dressing.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-25
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McGraw-Hill Education.
14. If the marginal rate of substitution between future and current consumption is less than
one, then this consumer exhibits

A. a positive time preference.

B. a negative time preference.

C. a neutral time preference.

D. an increasing preference.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

15. If $100 today is worth $150 to you in the future, then you exhibit

A. a positive time preference.

B. a negative time preference.

C. a neutral time preference.

D. a negative marginal rate of substitution.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-26
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McGraw-Hill Education.
16. A decrease in the interest rate will

A. produce an increase in current savings.

B. produce an increase in current consumption.

C. produce a decrease in current savings.

D. depend on the particular consumer's preferences.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

17. The Permanent Income and Life-Cycle Hypothesis imply that

A. consumers generally favor current consumption over future consumption.

B. the primary determinant of current consumption is permanent income.

C. the primary determinant of permanent income is current consumption.

D. consumers are more likely to save if they are uncertain about the future.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-27
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McGraw-Hill Education.
18. Differences in time preferences depend on

A. uncertainty regarding the future.

B. social preference.

C. differences in the relative size of expected future incomes.

D. the time.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

19. When people choose to wait for a kiss that they have won from a favorite movie star, they
are clearly

A. exhibiting a negative time preference and anticipation value.

B. exhibiting a positive time preference with anticipation value.

C. exhibiting a zero time preference.

D. irrational by rational choice standards.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-28
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McGraw-Hill Education.
20. In general, most people

A. have a positive time preference.

B. have a negative time preference.

C. value the present and the future about the same.

D. have a negative time preference for food and basic necessities and a positive time
preference for services and luxuries.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

21. One thousand dollars given to you a year from now is worth __________ to you today if the
relevant discount rate is 10%.

A. $1,000

B. $1,100

C. $909

D. $900

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-29
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22. In a diagram, consumer surplus is always represented by the area:

A. between the demand curve and the supply curve.

B. between the demand curve and the price.

C. below the demand curve.

D. above the demand curve.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-02 Use measures of consumer surplus to calculate the benefit from participation in specific
markets and design optimal two-part pricing schedules.
Topic: Consumer Surplus

23. If the demand function for apples is P = 1 - Q, how much consumer surplus does the
consumer gain when the price of the apples equals 5?

A. 25

B. 5

C. 20

D. 12.5

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-02 Use measures of consumer surplus to calculate the benefit from participation in specific
markets and design optimal two-part pricing schedules.
Topic: Consumer Surplus

5-30
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McGraw-Hill Education.
24. In analyzing the gasoline tax and subsidy policy discussed in the text, the final solution
illustrates that

A. consumers are worse off than they were before the policy began.

B. consumers do not cut back on fuel consumption.

C. the government is made better off financially.

D. social welfare increases.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

25. According to the analysis in your textbook, the school voucher program would

A. increase the level of spending on education.

B. decrease the level of spending on education.

C. leave the level of spending on education the same.

D. force some people to leave the public school system.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

5-31
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McGraw-Hill Education.
26. According to the analysis in your text, the school voucher program would

A. increase the quality of education.

B. decrease the quality of education.

C. not affect education quality, but would make lower income families better off.

D. increase the quality of education, but not improve the welfare of low income families.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

27. Colin's demand for golf at his local club each season is P = 50 - 2Q. If the golf course
charges $26 dollars per round of golf, how much could it charge Colin in a membership fee
before he would not play there?

A. $1,250

B. $144

C. $288

D. $312

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-02 Use measures of consumer surplus to calculate the benefit from participation in specific
markets and design optimal two-part pricing schedules.
Topic: Consumer Surplus

5-32
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McGraw-Hill Education.
28. If you had a windfall of $5,000 in the present time period and you save some of it, your
saving behavior would likely be due to the fact that

A. your marginal utility of present income falls as your income goes up.

B. the extra income changes the slope of your time preference indifference curves making
then steeper.

C. your indifference curves for present and future income are vertical.

D. your indifference curves for present and future are horizontal.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

29. When a product depicted on the horizontal axis of a typical indifference curve model of
behavior is taxed

A. the budget line becomes steeper.

B. the budget line becomes flatter.

C. the indifference curve of the consumer shifts right.

D. all the indifference curves of the consumer become steeper.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

5-33
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
30. If the demand function for city bus rides is P = 100 - 10Q and the present price of a ride is
50, then

A. raising prices will increase city revenue.

B. raising prices will decrease city revenue.

C. raising prices will not change city revenue.

D. from the information given it is not clear what would happen to city revenue if price is
increased.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-04 Use price elasticity of demand to analyze the effects of changes in prices and taxes.
Topic: Using Price Elasticity of Demand

31. Suppose your university decides to increase parking fees in order to deal with the shortage
of parking spaces. Nevertheless, the president of your student body convinces the
university to pay back the amount spent on higher parking fees to students in the form of
a rebate at the end of the school year. Therefore, the increase in parking fees will

A. not solve the parking shortage.

B. reduce demand for parking and hence alleviate the parking shortage.

C. will have no effect since it will be offset entirely by the rebate.

D. make the parking shortage even worse.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

5-34
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
32. Say an individual demand curve was given by P = 50 - 5Q. When the price is $25,
consumer surplus is around

A. $63.

B. $188.

C. $125.

D. $100.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-02 Use measures of consumer surplus to calculate the benefit from participation in specific
markets and design optimal two-part pricing schedules.
Topic: Consumer Surplus

33. Suppose an individual demand curve is given by P = 100 - 5Q, where P is the price of
smoothies and Q is the quantity she consumes. Assuming her income per week is $1,000
and the current price of smoothies is $5 each, by how much will her consumer surplus
decline if the price of smoothies increased to $10 each?

A. $92.5

B. $810

C. $950

D. $25

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-02 Use measures of consumer surplus to calculate the benefit from participation in specific
markets and design optimal two-part pricing schedules.
Topic: Consumer Surplus

5-35
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McGraw-Hill Education.
34. Say the bus authority in your city increased the typical bus fare from $1.00 to $1.50 and
that due to this increase total revenue increased by 20%. Based on this we know that the
price elasticity of bus rides in your neighborhood is (assume demand curve is linear):

A. 0.4.

B. 0.8.

C. 1.

D. 1.5.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-04 Use price elasticity of demand to analyze the effects of changes in prices and taxes.
Topic: Using Price Elasticity of Demand

35. You have $20,000 of current income and $45,000 of future income. The interest rate
between the current and future period is 2 percent. What is the maximum amount you
could consume in the future?

A. 65,400

B. 69,000

C. 20,400

D. 65,000

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-36
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McGraw-Hill Education.
36. You have $20,000 of current income and $45,000 of future income. The interest rate
between the current and future period is 2 percent. When you allocate consumption
optimally between the two periods the marginal rate of time preference between the two
periods is

A. -1.02.

B. -1.00.

C. -1.80.

D. 0.80.

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

37. According to the Life-cycle hypothesis, if a person received a payment roughly equals to
her current income her consumption would:

A. roughly double.

B. increase, but not by as much as the increase in income.

C. increase by more than the increase in income.

D. would not increase at all.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-37
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McGraw-Hill Education.
38. An interest rate increase to 4 percent will cause you to

A. save more of your income.

B. save less of your income.

C. be more time patient.

D. be more time impatient.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

39. Which of the following would be but best item for the local government to tax if its goal
was to raise revenue?

A. Water supply

B. Outdoor concert provided by the city

C. Weather reports on your phone

D. Leaf collection

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-04 Use price elasticity of demand to analyze the effects of changes in prices and taxes.
Topic: Using Price Elasticity of Demand

5-38
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
40. If you get great pleasure from anticipating a fun event which of the following is true?

A. You have a higher marginal rate of time preference than if you didn't get that pleasure.

B. Your intertemporal indifference curve is steeper than it would be without that pleasure.

C. You likely have more savings than you would have without the anticipatory pleasure.

D. All of these are true.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

41. Upon what is your current consumption dependent according to Milton Friedman?

A. The income you earn today.

B. The income you expect to earn later in life.

C. The present value of your lifetime income.

D. The future value of your present income.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation
Blooms: Remember
Difficulty: 1 Easy
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-39
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McGraw-Hill Education.
42. Budget A consists mostly of food, health care and an apartment and Budget B is made up
largely of Food, Entertainment, and Travel. If inflation is estimated by the consumer price
index which includes all the items listed above and travel and healthcare had the biggest
jump in prices, which of the following is true?

A. Budget A will likely have a less accurate estimate than budget B

B. Inflation will be equally biased for both budgets

C. Budget B will likely have a less accurate measurement than budget A

D. There should be no bias in this case because of the simple budget components

AACSB: Analytic
Accessibility: Keyboard Navigation
Blooms: Analyze
Difficulty: 3 Hard
Learning Objective: 05-03 Use the rational choice model to show how changes in prices and incomes affect consumer
well-being and identify one source of bias in the consumer price index.
Topic: Overall Welfare Comparisons

Essay Questions

5-40
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McGraw-Hill Education.
43. This graph below shows a consumer facing a choice between a cash gift or merchandise
of greater value.

Show, using a sketch graph, why a consumer prefers a cash gift rather than a larger gift of
merchandise.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-01 Analyze the effect of economic policy proposals by examining how they affect the consumer's
budget constraint.
Topic: Using the Rational Choice Model to Answer Policy Questions

5-41
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
44. Describe in words why the consumer price index overestimates inflation.

The CPI assumes the consumer is unable to substitute away from the items in his basket
that inflated the most. This makes it impossible for the consumer to fight off some of the
inflation by substituting toward more inexpensive goods in the market. Since inflation
never affects all goods the same, there will always be some substitutions that make
inflation less burdensome. Also, the CPI does not measure quality improvements that
might have taken place.

AACSB: Reflective Thinking

Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-03 Use the rational choice model to show how changes in prices and incomes affect consumer
well-being and identify one source of bias in the consumer price index.
Topic: Overall Welfare Comparisons

5-42
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
45. The graphs below show an economy of two people with identical incomes in two years.
They have different preference patterns as shown.

Why is the market for loanable funds not in equilibrium?

The supply of loanable funds exceeds the demand since neither person wants to borrow
and one person wants to save money.

AACSB: Reflective Thinking

Blooms: Understand
Difficulty: 2 Medium
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-43
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McGraw-Hill Education.
46. The graphs below show an economy of two people with identical incomes in two years.
They have different preference patterns as shown.

What will happen in the market to bring about equilibrium?

The interest rate will fall rotating the budget line counterclockwise around the bundle of
money each person has until the person on the left borrows the exact amount that the
person on the right chooses to save. This will require slight adjustments of the
indifferences curves as well.

AACSB: Analytic
Blooms: Apply
Difficulty: 3 Hard
Learning Objective: 05-05 Employ the rational choice model to examine choices between present and future consumption.
Topic: The Intertemporal Choice Model

5-44
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.