MID TERM ASSIGNMENT

MICROECONOMICS

SUBMITTED BY

Md Mujtaba
IPL01075
Section B

ON BEHALF OF

Dr. Meltem Ince Yenilmez Ma’am

 1.QUESTION:
Janet knows that she will ultimately face retirement. Assume that Janet will experience
two periods in her life, one in which she works and earns income, and one in which she
is retired and earns no income. Janet can earn $250,000 during her working period and
nothing in her retirement period. She must both save and consume in her work period
and can earn 10 percent interest on her savings.
a. Use a graph to demonstrate Janet's budget constraint.
b. On your graph, show Janet at an optimal level of consumption in the work period
equal to $150,000. What is the implied optimal level of consumption in her retirement
period?
c. Now, using your graph from part b above, demonstrate how Janet will be affected by
an increase in the interest rate on savings to 14 percent. Discuss the role of income
and substitution effects in determining whether Janet will increase or decrease her
savings in the work period.

ANSWER:

a. Janet can earn $250,000 during her working period. If she decides to spend during
the working period itself and does not save anything, this means she can consume
worth $250,000 during that period and cannot consume anything after retirement.
This forms the x-intercept as shown in figure 1

Now, if Janet decides to save the entire income for use after retirement, then she will
earn 10 % interest on her savings. Therefore, she will be able to consume $250,000 +
10% of $250,000 = $250,000+$25,000 = $275,000. This marks the y-intercept of Janet's
budget constraint.
Janet's budget constraint has been marked by line AB in

$ 275,000
consumption
Retirement period

Work period consumption

 b. If Janet decides to consume $150,000 in the work period, then she would have $250,000-
$150,000 = $100,000 that she would be able to save for consumption after retirement. She gets 10%
interest on her savings, so she would be able to consume worth $100,000 + 10% 0f $100,000 =
$100,000 + $10,000 = $110,000. Therefore, the optimal level of consumption in the retirement
period is $110,000. This has been depicted as point E on the budget line

A
$ 275,000
consumption
Retirement period

$110,000 E

$150,000 Work period consumption B

$25,000

c.

Now, consider that Janet gets 15% interest rates on her savings instead of 10% that she used to get
earlier.
Janet can still earn $250,000 during her working period. If she decides to spend during the working
period itself and does not save anything, this means she can consume worth $250,000 during that
period and cannot consume anything after retirement.
Now, if Janet decides to save the entire income for use after retirement, then she will earn 15 %
interest on her savings. Therefore, she will be able to consume $250,000 + 14% of $250,000 =
$250,000+$35,000= $285,000. This marks the y-intercept of Janet's budget constraint.

Janet's budget constraint has been marked by line CB

$285,000 C

$ 275,000
consumption
Retirement period

y
B
Work period consumption
Now two effects come into the picture:
• substitution effect: Since consumption in the current time period has become relatively more
expensive now, Janet should reduce working period consumption and increase retirement
consumption.
• income effect: this argues that Janet is now getting more interest, so in a way her income has
increased. Therefore, she should increase the consumption in working period as well as after
retirement.
From both these effects, it is clear that her post-retirement income would definitely go up but
whether her working time consumption goes up or not will depend upon which among the
substitution effect or income effect is powerful

QUESTION:
2. Assume that a consumer faces the following budget constraints.

a. Assuming that income is the same on both occasions, describe the difference in
relative prices between Panel A and Panel B.
b. If income in Panel B is $126, what is the price of good X?
c. If income in Panel A is $84, what is the price of good Y?
d. Assuming that the price of good X is the same on both occasions, describe the
difference in income and price of good Y between Panel A and Panel B.
 ANSWER:

a.

Here the relative price of X in panel A is 4 units of Y. And the relative price of X in panel B is 0.2
units of Y. The relative price of Y in the panel A is 0.25 units of X, whereas, in the panel B it is
4.5 units of X.

Assuming that income is the same on both occasions indicates that the price of good Y
is relatively higher in Panel A than Panel B Or we can say that the price of X is relatively
lower in Panel A than Panel B.

b.
126/14 =$9

So, if income in Panel B is 126, price of good X is $9

c.

84/ 7 =$12

So, if income in Panel A is 84, price of good Y is $12.

d.
ANSWER OF 3:

3. Use the graph shown to answer the following questions. Put the correct letter(s) in the
blank.

a. The elastic section of the graph is represented by section AB i.e., A to B.

b. The inelastic section of the graph is represented by section BC i.e., B to C.

c. The unit elastic section of the graph is represented by section B (Elasticity = 1)

d. The portion of the graph in which a decrease in price would cause total revenue to

fall would be BC i .e., B to C. (Elas tici ty is less er than 1)

e. The portion of the graph in which a decrease in price would cause total revenue to

rise would be AB i.e., A to B. (Elasticity is greater than 1)

f. The portion of the graph in which a decrease in price would not cause a change in

total revenue would be B (Elasticity = 1)

g. The section of the graph in which total revenue would be at a maximum would be

h. The section of the graph in which elasticity is greater than 1 is AB i.e., A to B.

(Elasticity is greater than 1)

i. The section of the graph in which elasticity is equal to 1 is B (Elasticity = 1)

j. The section of the graph in which elasticity is less than 1 is BC i.e., B to C. (Elasticity is

lesser than 1)

QUESTION4:

Suppose we are analyzing the market for hot chocolate. Graphically illustrate the impact
each of the following would have on demand or supply. Also show how equilibrium
price and equilibrium quantity would change.
k. Winter starts, and the weather turns sharply colder.
l. The price of tea, a substitute for hot chocolate, falls.
m. The price of cocoa beans decreases.
n. The price of whipped cream falls.
o. A better method of harvesting cocoa beans is introduced.
p. The Surgeon General of the U.S. announces that hot chocolate cures acne.
q. Protesting farmers dump millions of gallons of milk, causing the price of milk to rise.
r. Consumer income falls because of a recession, and hot chocolate is considered a
normal good.
s. Producers expect the price of hot chocolate to increase next month.
t. Currently, the price of hot chocolate is $0.50 per cup above equilibrium.

ANSWER4:
4. Answer the following questions based on the graph that represents J.R.'s demand for
ribs per week at Judy's Rib Shack.
a. At the equilibrium price, how many ribs would J.R. be willing to purchase?
b. How much is J.R. willing to pay for 20 ribs?
c. What is the magnitude of J.R.'s consumer surplus at the equilibrium price?
d. At the equilibrium price, how many ribs would Judy be willing to sell?
e. How high must the price of ribs be for Judy to supply 20 ribs to the market?
f. At the equilibrium price, what is the magnitude of total surplus in the market?
g. If the price of ribs rose to $10, what would happen to J.R.'s consumer surplus?
h. If the price of ribs fell to $5, what would happen to Judy's producer surplus?
i. Explain why the graph that is shown verifies the fact that the market equilibrium
(quantity) maximizes the sum of producer and consumer surplus.