Q: How is the real price of a good in year $$t$$ calculated using the Consumer Price Index (CPI)?

$$\text{Real Price}_t = \text{Nominal Price}_t \times \frac{\text{CPI}_{\text{base year}}}{\text{CPI}_t}$$

Question 1

Suppose the price of beer decreases from $$12 to 6 $$while the price of wine and income remain constant. According to consumer theory, what happens to the consumer's optimal bundle and the demand curve for beer?

Accepted Answer

The consumer's optimal bundle shifts to more beer and the demand curve for beer shifts to the right.

Question 2

Which of the following best describes the price-consumption curve?

Accepted Answer

A line through optimal bundles at each price of one good, holding the price of the other good and the budget constant.

Question 3

Mahdu views Coke and Pepsi as perfect substitutes. If the price of Coke, $$p$$, is less than the price of Pepsi, $$p^*$$, and his weekly cola budget is $$Y$$, how many cans of Coke will Mahdu buy?

Accepted Answer

He will buy $$\frac{Y}{p}$$ cans of Coke.

Question 4

What does the Engel curve illustrate?

Accepted Answer

The relationship between the quantity demanded of a single good and income, holding prices constant.

Question 5

If a 1% increase in income results in a 3% decrease in quantity demanded for a good, what is the income elasticity of demand for that good?

Accepted Answer

$$\xi = -3$$

Question 6

Which of the following statements is true about normal and inferior goods?

Accepted Answer

Normal goods have positive income elasticity, while inferior goods have negative income elasticity.

Question 7

A Giffen good is characterized by which of the following effects when its price decreases?

Accepted Answer

The substitution effect is positive, but the income effect is negative and larger in magnitude.

Question 8

How is the real price of a good in year $$t$$ calculated using the Consumer Price Index (CPI)?

Accepted Answer

$$	ext{Real Price}_t = 	ext{Nominal Price}_t 	imes \frac{	ext{CPI}_{	ext{base year}}}{	ext{CPI}_t}$$

Question 9

What is the main limitation of using the CPI for cost-of-living adjustments in long-term contracts?

Accepted Answer

The CPI ignores substitution toward relatively inexpensive goods when prices change disproportionately.

Question 10

If Jackie’s utility depends on both goods and leisure, and her wage increases, what is the likely effect on her labor supply if leisure is a normal good?

Accepted Answer

She may work more or fewer hours depending on the relative sizes of the income and substitution effects.

Question 11

Suppose Enrico receives a no-strings-attached scholarship that increases his unearned income $$Y^*. $$According to labor-leisure theory, what is the most likely effect?

Accepted Answer

He will work fewer hours and his utility will increase.

Question 12

Which formula correctly expresses the labor-leisure time constraint?

Accepted Answer

$$H = 24 - N$$

Question 13

If the supply curve of labor bends backward at high wages, what does this imply about the income and substitution effects?

Accepted Answer

The income effect dominates at high wage levels, leading to fewer hours worked.

Question 14

If the marginal tax rate increases beyond a certain point, what is the likely effect on U.S. long-run tax revenue according to the Laffer curve?

Accepted Answer

Tax revenue will decrease after reaching a maximum.

Question 15

Which of the following best describes the substitution effect of a price decrease for a normal good?

Accepted Answer

The consumer buys more of the good because it is now relatively cheaper.

Question 16

A true cost-of-living index differs from the CPI in that it:

Accepted Answer

Holds utility constant over time.

Question 17

If a good is both inferior and normal at different income levels, what does its Engel curve look like?

Accepted Answer

It first slopes upward and then bends backward as income increases.

Question 18

If Mahdu's weekly cola budget increases by $$p ($$the price of Coke), how many more cans of Coke can he buy per week if Coke is cheaper than Pepsi?

Accepted Answer

One more can per week.

Applying Consumer Theory: Demand, Income, Substitution, and Labor Supply

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