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SUGGESTED SOLUTIONS FOR MAY/JUNE 2015
QUESTION 1
1a. Consider the following baskets of goods:
FOOD CLOTHING
A 8 3
B 6 6
C 3 8
If preferences satisfy all requirements, is A preferred to C or C to A? Explain your answer.
Basket A has more food than basket C.
Basket C has more clothing than basket A.
Therefore, basket A and C cannot be compared without additional information.
1b. An island economy produces only two goods – coconuts and pineapples. There are five
people (A, B, C, D and E) living on the island, with these preferences:
A has a strong preference for
pineapples. B has a strong preference
for coconuts.
C doesn’t care for pineapples (assigns no value to
them). D doesn’t care for coconuts (assigns no value to
them).
E will only consume pineapples and coconuts in the fixed proportion of one pineapple to one
coconut.
For each of these five individuals, construct a representative indifference curve
with pineapples on the horizontal axis and coconuts on the vertical axis.
Person A:
Coconuts
A
Pineapples
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Person B:
Coconuts
B
Pineapples
Person C:
Coconut
C
Pineapple
Person D:
Coconut
D
Pineapple
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Person E:
Coconuts
E
Pineapples
1c. The diagram below depicts the change in optimal consumption bundles for Kgomotso when the
price of bread decreases. Decompose the change into the income and substitution effects. Indicate
the total effect, income effect and substitution effect in the diagram. (6 marks)
Food
bread
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Food
A hypothetical budget line must be constructed to show income effect, substitution effect and total
effect.
QUESTION 2
2a. A fast-food restaurant currently pays R20 per hour for labour and R40 per hour to rent ovens and
other kitchen machinery. The restaurant uses seven hours of labour time per unit of machinery time.
(i) Determine whether the restaurant is minimising its cost of production when the ratio of marginal
products (capital to labour) is 10.
If the firm is minimizing its costs of production, then the MRTS will equal a ratio of prices of
inputs.
The ratio of prices Pk / PL = R40 / R20= 2
And the MRTS of capital for labour (MPk / MPL) = 10.
Since these two ratios are not equal, the firm is not minimizing costs.
(ii) If not, what adjustments are called for to improve the efficiency of resource use? (2 marks)
To increase efficiency in the use of inputs, the firm should use more capital and use less labour to
make the ratios equal.
Since these two ratios are not equal, the firm should change the mix of inputs.
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SUGGESTED SOLUTIONS FOR MAY/JUNE 2015
QUESTION 1
1a. Consider the following baskets of goods:
FOOD CLOTHING
A 8 3
B 6 6
C 3 8
If preferences satisfy all requirements, is A preferred to C or C to A? Explain your answer.
Basket A has more food than basket C.
Basket C has more clothing than basket A.
Therefore, basket A and C cannot be compared without additional information.
1b. An island economy produces only two goods – coconuts and pineapples. There are five
people (A, B, C, D and E) living on the island, with these preferences:
A has a strong preference for
pineapples. B has a strong preference
for coconuts.
C doesn’t care for pineapples (assigns no value to
them). D doesn’t care for coconuts (assigns no value to
them).
E will only consume pineapples and coconuts in the fixed proportion of one pineapple to one
coconut.
For each of these five individuals, construct a representative indifference curve
with pineapples on the horizontal axis and coconuts on the vertical axis.
Person A:
Coconuts
A
Pineapples
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Person B:
Coconuts
B
Pineapples
Person C:
Coconut
C
Pineapple
Person D:
Coconut
D
Pineapple
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Person E:
Coconuts
E
Pineapples
1c. The diagram below depicts the change in optimal consumption bundles for Kgomotso when the
price of bread decreases. Decompose the change into the income and substitution effects. Indicate
the total effect, income effect and substitution effect in the diagram. (6 marks)
Food
bread
Downloaded by: Mgwebs
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|
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Distribution of this document is illegal
, Stuvia.com - The study-notes marketplace
Food
A hypothetical budget line must be constructed to show income effect, substitution effect and total
effect.
QUESTION 2
2a. A fast-food restaurant currently pays R20 per hour for labour and R40 per hour to rent ovens and
other kitchen machinery. The restaurant uses seven hours of labour time per unit of machinery time.
(i) Determine whether the restaurant is minimising its cost of production when the ratio of marginal
products (capital to labour) is 10.
If the firm is minimizing its costs of production, then the MRTS will equal a ratio of prices of
inputs.
The ratio of prices Pk / PL = R40 / R20= 2
And the MRTS of capital for labour (MPk / MPL) = 10.
Since these two ratios are not equal, the firm is not minimizing costs.
(ii) If not, what adjustments are called for to improve the efficiency of resource use? (2 marks)
To increase efficiency in the use of inputs, the firm should use more capital and use less labour to
make the ratios equal.
Since these two ratios are not equal, the firm should change the mix of inputs.
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