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(ECON198)[2008](s)midterm~1659^_10008.pdf
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Department of Economics, HKUST
ECON 198
MICROECONOMIC THEORY I

Prof. S. F. Leung

Midterm Examination
This is a closed book examination. You have 80 minutes to complete the test. Write coherently, lucidly, and legibly. Always explain your answer. The maximum score for this exam is 80 points. Points are marked next to the questions and may be served as a rough guide to how much time you should allocate on each question. Points will be deducted for irrelevant materials. Use mathematics and/or diagrams wherever appropriate to support your answer.
1. (20)
Indicate whether each of the following statements is TRUE, FALSE, or UNCERTAIN, and explain your answer. Use mathematics and/or diagrams to support your answer.
(a)
Few people lick their platters clean (i.e., most people do not consume all the food on the plates). Their behavior contradicts the axiom that preferences are monotonic.

(b)
For preference relations, transitivity implies monotonicity (i.e., if preference relations are transitive, then they are also monotonic).

(c)
An unemployed person who is living in Wan Chai plans to move to Tuen Mun (a town in New Territories) next month. He will likely remain unemployed after the move.

(d)
In a two good model, if one good is an inferior good, then the other must be a luxury good.

1

2.
(7)

The Financial Secretary Henry Tang has just proposed in his 2007 Budget that the duty rate on beer and other types of liquor containing not more than 30 per cent of alcohol be reduced from the current 40 per cent to 20 per cent, and that on wine from the current 80 per cent to 40 per cent. What will be the effect of the reduction in the duty rate (i.e., tax rate) on alcoholic beverage trades, the catering industry, and tourism? Use indifference curve analysis (and supply-and-demand analysis if necessary) to support your answer.

3.
(5)

If Johns utility function is (, )=
xy, then xand y are perfect substitutes to him. The
Uxy
reason is as follows. If (, )=
x, then Uxy (, ) =Uyx , ) (e.g., U(1, 2) = U(2,1)
Uxy y ( =
2 ).
This means that xand y are perfectly interchangeable and hence perfectly substitutable. Do you agree? Discuss.
4. (8)
Suppose that John sells a commodity with zero costs of production. The commodity is a luxury good to his customers. John considers giving money to his customers because he believes that the amount he earns from them will be larger than the amount he gives to them. His argument is that the money will raise the customers income and they will spend more than the increase in income on the commodity because it is a luxury good.
Do you agree with John? Discuss. Is it possible for John to be correct? Explain.
5. (7)
John consumes only potato chips and coke. When the price of potato chips increases, John decreases his consumption of coke.
(a)
Illustrate the substitution and income effects from an increase in the price of potato chips. Be su