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University of Toronto, Department of Economics, ECO 204 2011 Summer Ajaz Hussain
TEST 1
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SCORES
Question Total Points Score
1 5
2 5
3 20
4 70
Total Points = 100

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THERE IS A WORKSHEET AT THE END OF THE TEST
GOOD LUCK!

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QUESTION 1 [5 POINTS]
Consider the typical family in China that can have either zero or one child, and can consume all other
goods in any amount. Graph and write down an algebraic definition of the typical Chinese familys
consumption set where good 1 is # of children and good 2 is everything else. Given your answer
does the typical Chinese family have monotone preferences? What about convex preferences? Give a
brief explanation and show all calculations.

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QUESTION 2 [5 POINTS]
Graph and write down an algebraic definition of the consumption set of a driver who stops at a gas
station offering a free car wash with a purchase of at least 10 gallons of gasoline. Let good 1 be gallons
of gasoline and good 2 be #s of car washes. Given your answer does such a driver have monotone
preferences? What about convex preferences? Give a brief explanation and show all calculations.

Answer

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QUESTION 3 [20 POINTS]
The authors of the paper Household Demand for Broadband Internet in 2010, published in the B.E.
Journal of Economics Analysis and Policy in October 2010, estimated the following utility function for the
average broadband users preferences over various characteristics of broadband internet service:




Cost
Fast speed internet service
Very fast speed internet service
Reliable internet service
Priority of download service
Telehealth (the ability to connect with health professionals online)
Mobile laptop (whether laptop can be connected to internet)
Video phone (whether free phone calls can be made over internet and other party seen on
videophone)
movie rental (whether High Definition movies can be rented online)

(a) [5 POINTS] Does the average broadband user have strongly monotone preferences over the various
characteristics of broadband internet service? Give a brief explanation and show all calculations.

















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(b) [5 POINTS] Holding all other characteristics constant and treating as good 1 and as good 2,
plot an indifference curve for an average broadband user. Calculate the between cost and
Very Fast Service and briefly discuss how broadband providers can use this information. Show all

calculations.

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(c) [5 POINTS] Holding all other characteristics constant and treating as good 2 and as good 1,
plot an indifference curve for an average broadband user. Calculate the between cost and
Very Fast Service and briefly discuss how broadband providers can use this information. Show all

calculations.

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(d) [5 POINTS] Based on your answer to part (c), indicate whether the average broadband user has a
taste for variety in the sense of having strictly convex preferences. If required, use the graph below.

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QUESTION 4 [70 POINTS]
The following table contains figures for Apples iPod sales and price in March 2010 and March 2011:
March 2010 March 2011
Units of iPod sold (millions) 10.885 9.017
(Average) Price per iPod (approx.) $171 $177
Source: Apples 10-Q Report Filed with the SEC, 1st quarter 2011

(a) [5 POINTS] Based on the information in the table derive an equation for Apples iPod demand curve
where price per iPod and iPod units sold in millions. State all assumptions and show all
calculations.




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(b) [5 POINTS] Based on the answer to part (a) above what is the highest price customers will pay for an
iPod, the maximum potential market size for iPods, the price reduction needed to sell an additional 1m
iPods and the sales reduction from a $1 increase in iPod prices. State all assumptions and show all
calculations.


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(c) [5 POINTS] Assuming Apple has ample capacity calculate the revenue maximizing output and price.
State all assumptions and show all calculations. Do not have the constraint in your solution.

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(d) [5 POINTS] For your answer in part (c) what is the impact on optimal revenues from a, ceteris paribus,
a $1 increase in the maximum price customers are willing to pay for an iPod? What about a 1% decrease
in the maximum price customers are willing to pay for an iPod? State all assumptions and show all
calculations.

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(e) [10 POINTS] Assume that in March 2011, Apples iPod capacity in 2011 was 11m units. What is the
revenue maximizing output and price if Apples management insists on producing at 100% capacity?

State all assumptions and show all calculations. Do not have the constraint in your solution.


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(f) [5 POINTS] Based on your answer in part (e) is the capacity of 11m/year optimal? If not, what would
you advise Apple to do? Briefly explain your answer, state all assumptions and show all calculations.

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(g) [5 POINTS] On May 20
th
2011 there was an explosion at one of the facilities in Chengdu, China
producing iPods
1
. Given your answer in part (e) what is the impact on optimal revenues from (lets say) a


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(h) [10 POINTS] Once again assume that in March 2011, Apples iPod capacity in 2011 was 11m units.
What is the revenue maximizing output and price if Apples management opts to produce at less than or
equal to 100% capacity? State all assumptions and show all calculations. Do not have the constraint

in your solution.


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(i) [5 POINTS] On May 20
th
2011 there was an explosion at one of the facilities in Chengdu, China
producing iPods
2
. Given your answer in part (h) what is the impact on the optimal revenues from (lets


say) a 2% decrease in iPod capacity? State all assumptions and show all calculations.



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(j) [5 POINTS] Ceteris paribus, what is the impact on the optimal revenues in part (h) from a 3% increase
in the maximum price customer are willing to pay for iPods? State all assumptions and show all
calculations.

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(k) [10 POINTS] Once again assume that in March 2011, Apples iPod capacity in 2011 was 11m units.
What is the revenue maximizing output and price if Apples management insists on producing at less
than or equal to 100% capacity? State all assumptions and show all calculations. This time, solve the

problem with the constraint in your solution.





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WORKSHEET