S. Klepper, Economics 73-100, Fall 2009

Solution to Mini-test 2

If the percentage increase in the income of Social Security recipients equaled the percentage increase in the price of food, then the maximum amount of food that Social Security recipients could have purchased in 1990 must have been the same as the maximum amount they could have purchased in 1960. Alternatively, if the percentage increase in the price of shelter was less than the percentage increase in the price of food, then the percentage increase in the income of Social Security recipients was greater than the percentage increase in the price of shelter. This implies that the maximum amount of shelter Social Security recipients could have purchased in 1990 was greater than the maximum amount of shelter they could have purchased in 1960. The budget lines of Social Security recipients in 1960 and 1990 corresponding to these facts are graphed in the figure below.

The budget line for 1990 is outside the budget line for 1960, indicating that all Social Security recipients sustained an increase in their real income between 1960 and 1990. The graph also indicates that the bundle chosen in 1960 was inside the 1990 budget line, hence all Social Security recipients must have been better off in 1990 than 1960 because in 1990 they could have purchased the bundle of food and shelter they chose in 1960 and more of both goods. It is not possible to tell whether all Social Security recipients would have consumed more shelter but less food in 1990 than 1960. Although the price of shelter declined relative to the price of food, the purchasing power of Social Security recipients also increased, which could have induced greater consumption of both goods. The point labeled possible 1990 choice illustrates a possible combination of food and shelter that some Social Security recipients might have chosen in 1990 that involves more of both food and shelter than the bundle chosen in 1960.

Based on this description, the answers to the individual questions are:

_____1. True

_____2. True

_____3. True

_____4. False

_____5. True