Indicate whether you believe the following statements are true, false or that yo
ID: 1199043 • Letter: I
Question
Indicate whether you believe the following statements are true, false or that you are uncertain. Support your answer with an explanation in the form of a paragraph, a graph or a short proof. Utility maximizing individuals consume goods at the point the ratio of marginal utility for any two goods is equal to their price ratio. If Marshalian demand for good x_1 = 4P-5_1P_2M^-5, where P_1 is the price of x_1 and P_2 is the price of other good and M is income, then x_1 is a normal good. A firm facing a demand curve equal to P = 10 - 2 Q, has an inelastic price elasticity of demand at price equal to 4. If the marginal cost of production of a firfn less than average cost of production, the firm has economies of size. Profits are equal to zero in a competitive industry.Explanation / Answer
(1) True.
Utility is maximized when ratio of marginal utilities of the goods consumed equals their price ratio. This ensures that in optimality, the consumer is paying the same marginal utility per dollar for each good consumed.
(2) False
A good is normal if its consumption increases with increasing income. Here, as M (income) increases, consumption of X1 (given by its demand function) decreases. So, X1 is inferior good.
(3) True
P = 10 - 2Q [2Q = 10 - P, or Q = 5 - 0.5P]
When P = 4, 2Q = 10 - 4 = 6 & Q = 3
Price elasticity of demand = (dQ/dP) x (P / Q) = - 0.5 x (4 / 3) = - 0.67
Since absolute value of elasticity is 0.67 < 1, demand is inelastic at this point.
(4) False
When MC < AC, it is called economies of scale (not size).
(5) False
In perfect competition, firms make excess (positive) economic profit in the short run. Only in the long-run, economic profits are zero. So we can't generally say that competitive firms always make zero profits.