Question 1 Consider an economy with two goods, referred to as \good 1″ and \good 2″, and two consumers, Kaja and Patrick. Let A denote the market bundle (2; 3), B the market bundle (3; 3), C the market bundle (3; 2), and D the market bundle (2; 4). (a)Would you expect Kaja to prefer A to B, or B to A? Justify your answer.

Important Guidelines for the Exam:

1.The answer paper must be written and prepared individually. Collaboration with others is not permitted and is considered cheating.

2.All answer papers are automatically subjected to plagiarism control. Students may also be called in for an oral consultation as additional veri cation of an answer paper.

3.Students do not need to include a list of literature for this exam.

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Question 1

Consider an economy with two goods, referred to as \good 1″ and \good 2″, and two consumers, Kaja and Patrick. Let A denote the market bundle (2; 3), B the market bundle (3; 3), C the market bundle (3; 2), and D the market bundle (2; 4).

(a)Would you expect Kaja to prefer A to B, or B to A? Justify your answer.

(b)Would you expect Kaja to prefer A to C, or C to A? Justify your answer.

(c)You are told that from Patrick’s viewpoint C and D lie on the same indi erence curve. Does Patrick prefer A to C, or C to A? Justify your answer.

(d)Would you expect Kaja’s indi erence curves to be upward or downward sloping? Justify your answer.

(e)Explain with a diagram why Patrick’s indi erence curves cannot intersect.

(f)You are told that Patrick’s preferences can be represented by the utility function u(x1; x2) = ln(x1) + 2 ln(x2). What is Patrick’s Marginal Rate of Substitution (MRS) between the two goods at the market bundle (1; 2)?

(g)You are told that the price of good 1 is 2 and that the price of good 2 is 5. If Patrick has an income of 20, can market basket A represent Patrick’s consumption choice? Justify your answer.

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Question 2

Consider some good with a perfectly competitive market.

(a)Illustrate with a diagram the concept of consumer surplus.

(b)Illustrate with a diagram the concept of producer surplus.

(c)Explain with a diagram why, in the absence of externalities, the market-clearing price maximizes social welfare, de ned as the sum of consumer and producer surplus.

(d)Explain with a diagram why, in the presence of consumption externalities, the market-clearing price does not maximize social welfare.

What measures can the government take in order to increase social welfare in the pres-ence of consumption externalities? Illustrate your answer with a diagram

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