Question

Assess the validity of the following: If true, mark true; if false, explain why the statement is false.  

1. An increase in disposable income decreases the quantity demanded of inferior goods.
2. Constant elasticity demand curves imply that expenditure (or revenue) always stay the same.
3. Marginal Revenue is positive as long as Total Revenue is also positive.
4. If in a model with only two goods the MRS_{X, Y} is constant and greater than the price ratio P_X/P_Y, the consumer buys no X.
5. The law of diminishing returns does not apply if the Total Product of labor were to be linear.
6. If over the relevant range the Price Consumption Curve for good Y is parallel to the y-axis, the demand for good X is perfectly inelastic.
7. In stage I of the production process, Total Product always increases at an increasing rate.

Answer 1

a) For inferior goods, as income increases, the demand for that good decreases as people prefer to buy less of that good. The given statement is true.

b) Revenue depends on price effect and quantity effect. With increase in price, revenue increases. This is the price effect. With increase in price, quantity decreases. This is the quantity effect. For constant elasticity of demand, change in quantity changes in same proportion to the change in price. Thus, the given statement is true.

c) Marginal revenue is the change in total revenue due to change in quantity by 1 unit. Marginal revenue initially increases, reaches a maximum, and then becomes negative. At the point MR becomes zero, total revenue is positive. Thus, the given statement is false.

d) If MRSx.y > Px/Py and MRSx.y = MUx/MUy. Qe have, MUx/Px>MUy/PY. The slope of the utility function is greater than the slope of the budget line. There will be a corner solution as MRS constant means utility function is linear.Consumer buys only X. Thus, the given statement is false.

e) If total product is linear, then marginal product is constant. Thus, diminishing returns won't apply. Thus, the given statement is true.

f) If price consumption of good Y is parallel to Y axis, then the quantity of X does not change due to change in price of Y. Thus, the given statement is true.

g) In stage I, initially thee total product increases at an increasing rate. However, after the marginal product reaches maximum, it decreases. Thus, the given statement is false.