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Midterm

ECO206Y1 Study Guide - Midterm Guide: Ordinary Income, Slutsky Equation, Lump Sum


Department
Economics
Course Code
ECO206Y1
Professor
all
Study Guide
Midterm

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ECO206 Microeconomic Theory
1. Midterm I Structure
Based on analysis of past midterms, there are five main topics that are covered in the first midterm of
ECO206: Budget constraints, utility maximization, income and substitution effects, government
grants/taxes and labor supply. The midterm is usually about 2 hours long and consists of 3 to 5
questions with 3 to 5 sub-questions per question. The total number of questions, including sub-
questions, is roughly 12 to 15.
2. Midterm I Statistics
Topics/Years
2009
2011*
2012
Budget Constraints
1
1
1
Utility Maximization
2
4
7
Income and
Substitution Effects
1
1
1
Government
Grants/Taxes
4
5
2
Labor Supply
4
3
4
Total
12
14
15
*In Midterm I of 2011, the test also included two questions on topics: normal goods and cross-price elasticity of demand. Neither
of these topics appeared in midterm I of 2009, 2012.
0
1
2
3
4
5
6
7
8
2009 2011 2012
Midterm I Questions Statistics
Budget Constraints
Utility Maximization
Income and Substitution Effects
Government Grants/Taxes
Labor Supply

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Topic 1: Budget Constraints
Knowledge Summary:
The budget constraint, for the purpose of the first midterm, gives a combination of 2 goods (x
and y) that the individual can consume given his/her constraints: price of good x (px), price of
good y (py) and the individual’s income (E).
Critical assumption: the individual spends all his income on consuming goods x and y. Therefore
we can write the budget constraint as: px*x + py*y = I
Furthermore, the budget constraint is a linear function and this tells us that the consumer is a
price taker.
The three properties above help us derive the budget constraint graphically:
Slope: - (px)/(py), the slope is the
measure of the opportunity cost
Moving from left to right along the
budget constraint implies that we are
consuming more of x and less of y.
A change in income (I) causes a
shift in the budget constraint
A change in px causes the budget
constraint to pivot through the vertical
intercept (0, I/py). An increase in px causes
the budget constraint to pivot inward. A
decrease in px causes the budget constraint
to pivot outward.
A change in py causes the budget
constraint to pivot through the horizontal intercept (I/px ,0). Movement of the budget constraint is
identical to the movement described in the previous bullet point.
Summary of Questions to be asked:
Graphical representation of a budget constraint given 2 goods, their respective prices and the
consumer’s income: graph the intercepts as shown in the graph above and connect them with
a line, label the intercepts, the value of the slope and the axes.
Graphical change in the budget constraint due to changes in prices and/or income: recall
change in income shift, and change in price change in slope/pivot
Derive the budget constraint equation in order to solve an optimization problem: refer to
utility maximization section below to see an optimization problem.

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Related Past Test Questions:
2012 Midterm 1 Question 1
2009 Midterm 1 Question 4a-i
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