Economics 410-002

Intermediate Microeconomic Theory Midterm 1 Review

This Midterm consists of 10 multiple choice questions and 2 Long Form. The
sections have equal weight. The numbers have been simplified so that no
calculators are permitted on this exam. There will be at least 1 MC from each
chapter covered, the other questions will be a mix of the concepts covered.
1. Preferences (ch. 3)
Rational Preferences
o Completeness everything is compared to each other
o Transitivity a doesnt equal a
Well-Behaved Preferences
o Monotonicity more is always preferred for all goods
o Convexity averages are preferred to extremes
Indifference Curves and their properties
Goods, Bads, Neutrals
o Good more is always better
o Bad getting less is always better
o Neutral consumer is indifferent between any amount
Special Cases Covered
o Perfect substitutes if the agent cares only about total
consumption not the individual makeup
downward sloping curve
o perfect compliments if the agent cares only about the ratio
L shaped lines
Satiation and Non-Convexity
o Satiation section off quadrants based off of given point
(clockwise starting at top right = BB, BG, GG, GB) and it makes
rings of circles converging on each other
o Non-convexity - ?
Marginal Rate of Substitution and relation to ICs
o It is the slope of the indifference curve
o MRS = dx/dy
o MRS = MUx/MUy
o MRS = y/x
2. Utility (ch. 4)
Relationship between Preferences and Utility
o A complete, transitive, and continuous preference can be
represented by a utility function
Ordinal vs Cardinal
o Ordinal only order matters (ex: 3 is bigger than 2)

o Cardinal the level (magnitude) also matters (ex: 3 is 1.5 bigger

than 2)
Positive Monotonic Transformations
o V=f(u) f is strictly increasing
o V(x,y)=x1/2y1/2
o F=u2, v=xy
o MRS =y/x
o ???
Goods, Bads and Neutrals using utility
o Good if du/dx > 0
o Bad if du/dx < 0
o Neutral if du/dx = 0
Special Cases Covered
o Perfect substitutes negative slope straight line (makes graph
look like right triangle)
o Perfect compliments ex -> min function with 2 ice cubes per 1
glass of water
o Cobb-Douglas: u(x,y)=xayb
Normal downward sloping lines
o Quasi-linear: u(x,y)=f(x)+ay
Lines sweeping across (still concave)
Marginal Utility
MRS and relation to utility

3. Budget Sets (ch. 2)

Budget Constraint and Affordable Bundles
o Budget constraint -> I = Pxx + Pyy
o Affordable when px + py < I
Intercepts, Slope and Opportunity Cost
o Slope = opportunity cost of consuming x more goods
= -px/py
o Intercepts are I/py and I/px (x with x and y with y)
o The line of actual budget constraint: y = -px/pyx+ I/py
Price changes, taxes and subsidies
o Px increase: 1 y intercept, 2 x intercepts, one closer to y axis is
new, so new BC has steeper slope
Tax is same as this, if you have t tax per unit
o Taxing 2 things at once puts us back to same graph as income
doubling, where you have 2 straight lines. Except in this case
(taxes) your new BC is closer to the Y axis
Income changes, transfers and consumption restrictions
o Income doubles shift BC out to the right

o Government transfer plateau on top and draw parallel straight

line off that plateau.
Make sure slopes are the same
o Non-linear pricing the graph with the kink in it. ????
4. Choice (ch. 5)
Demand functions
Interior Solutions and Conditions for them
o
Solving for Demand using the Lagrangian
o L(x,y) = u(x,y) + [I-Pxx-Pyy]
o Take first order conditions
o Solve x and y for and then put them equal to each other
o Solve for y as a function of x [or vice versa, whichevers easier]
o Plug into budget constraint and solve for the variable
o Plug that solved variable into the budget constraint to get the
other variable
o Then you have the utility (your two variables)
o **if you get min function, put utility function equal to each other
and skip to steps where youre solving into budget constraint
this also means perfect compliments
o **if you get actual numbers (ex: = ) its going to be perfect
substitutes
Corner Solution
o (X*,0) or (0,Y*)
o if MUx/Px > MUy/Py then its the x* corner solution
o (x*,0) = (I/px,0)
Utility Level at Demand
5. Demand (ch. 6)
Law of Demand, Giffen Good and Demand Curve
o Law of demand: dx/dPx < 0
o Giffen good: dx/dPx > 0
Normal Good, Inferior Good and Engel Curve
o Normal good: dx/dy > 0
o Inferior good: dx/dy < 0
o Engel curve thing where you trace one graphs points onto
another graph below it- all prices being held constant
Substitutes and Complements
o Substitutes: dx/dPy < 0
o Compliments: dx/dPy > 0
6. Income and Substitution Effects (ch. 8)

What is the SE and how to derive

What is the IE and how to derive
What is the TE and how to derive
Relationship to ideas from previous chapters
Graphical analysis

7. Uncertainty
Expected Utility
o Gambling example if you want to figure out $, plug $ in, but if
you want to figure out utility, plug the utility in
Risk Aversion, Neutrality and Loving
o Risk aversion: u[e(c)] > e[u(c)]
o Risk neutral: u[e(c)] = e[u(c)]
o Risk loving: u[e(c)] < e[u(c)]
Budget Constraint Under Uncertainty
o EU = ,u(ci)+2u(c2)
o Which boils down to -> (1/2)(MU2/MU1) = -dc2/dc1
So all it really adds is the s
8. Intertemporal Choice
Nominal Interest Rate, Inflation and Real Interest Rate
o
Intertemporal Budget Constraint
o Q=f(L,K) ?
Present and Future Values
o PV = m/(1+r)
o FV = m(1+r)