Please answer four out of the following questions. Please use this book as the main source: Macroeconomics 6th edition, 2005 by Pindyck and Rubinfeld.
1. Explain the meaning and nature of a representative households so-called Aindifference map. For a given level of consumption expenditure (equals income if there are no savings), and given prices for consumption goods, explain how this household maximizes its Autility; i.e. its real income in terms of its subjectively-determined well-being.
2. Explain the difference between the “substitution effect” and the “income effect” whenever the price of a consumption good changes, and use this distinction to explain:
a) The (rare) phenomenon of a “Giffen good” in which consumers buy more of something when its price rises;
b) The possibility of backward-bending (negatively-sloped) labor supply; and
c) The possibility of backward-bending savings (capital supply) curves.
3. Discuss the concepts and measurement of:
a) Acompensating variation (of income);
b) Aequivalent variation (of income) and
c) Consumer surplus, including how they can be used by either firms or government trying to:
1) Recoup the benefits to their customers of an actual price cut;
2) Benefit their customers as if they had cut prices; or
3) Evaluate the benefits of a service that will have a zero price.
4. Economists often assume that the long-(and short-) run average cost curves are “U”-shaped. Explain the assumptions about long-run production – including the rationale of cost minimization in terms of isoquants and cost constraints – that underlie these cost curves.
5. Explain:
a) why firms in a competitive industry will normally operate at the bottom (minimum point) of their long-run average cost curves; and
b) ways in which governments might subsidize firms in a Afavored industry, including an analysis of the direct, Adollar costs of such schemes as well as their economic costs (otherwise known as Adeadweight loss).
6. Illustrate the concept of “general equilibrium using a 2-sector production-possibilities frontier and a “community” indifference map. Explain the significance of the point of tangency at which the marginal rate of transformation in production (between ‘a’ and ‘b’) equals the marginal rate of substitution in consumption (for every household). What happens to real income if there are taxes or subsidies?
7. Explain the concept of a A Social Welfare Function (SWF); i.e. a map of social Aindifference curves, particularly the extremes of so-called AParetian and ARawlsian SWFs. How could the degree of curvature (Aelasticity of substitution) of a SWF be measured? Could we be sure that this measurement is truly a reflection of societal values, given the nature of majority voting systems?