MicroEconomics Chapter 7 Roger A. Arnold 10th edition self-test

Alesandro purchases two goods, X and Y, and the utility gained for the last unit purchased of each is 16 utils and 23 utils, respectively. The prices of X and Y are $1 and $1.75, respectively. Is Alesandro in consumer equilibrium? Explain your answer.

Alesandro is not in consumer equilibrium because the marginal utility per dollar of X is 16 utils and the marginal utility per dollar of Y is 13.14 utils. To be in equilibrium, a consumer has to receive the same marginal utility per dollar for each good consumed.

What does falling total utility imply for marginal utility? Give an arithmetical example to illustrate your answer.

If total utility declines, marginal utility must be negative. For example, if total utility is 30 utils when Lydia consumes 3 apples and 25 utils when she consumes 4 apples, the fourth apple must have a marginal utility of −5 utils. Chapter 1 explains that something that takes utility away from us (or gives us disutility) is called a bad. For Lydia, the fourth apple is a bad, not a good.

In a two-good world (goods A and B), what does it mean to be in consumer disequilibrium?

It means the marginal utility-price ratio for one of the goods is higher than the ratio for the other good.

Summarize David Friedman's explanation of the endowment effect.

The endowment effect relates to individuals valuing X more highly when they possess it than when they don't but are thinking of acquiring it. Friedman argues that if we were to go back in time to a hunter-gatherer society when there were no well-established property rights (no rules as to what is mine and thine), we would find individuals who would fight hard to keep what they possessed but would not fight as hard to acquire what they did not possess. These individuals would have a higher probability of surviving than those who would fight hard in both cases. Thus, those who would fight hard only to keep what they possessed would have a higher probability of reproductive success. The characteristic of holding on to what you have has been passed down from generation to generation, and, although it may not be as important today as it was in a hunter-gatherer society, it still influences behavior.

State and solve the diamond-water paradox.

The paradox is that water, which is essential to life, is cheap, and diamonds, which are not essential to life, are expensive. The solution to the paradox depends on knowing the difference between total and marginal utility and the law of diminishing marginal utility. By saying that water is essential to life and diamonds are not essential to life, we signify that water gives us high total utility relative to diamonds. But then someone asks, "Well, if water gives us greater total utility than diamonds do, why isn't the price of water greater than the price of diamonds?" The answer is, "Price isn't a reflection of total utility; it is a reflection of marginal utility. The marginal utility of water is less than that of diamonds." This answer raises another question, "How can the total utility of water be greater than that of diamonds, but the marginal utility of water be less than that of diamonds?" The answer is based on the fact that water is plentiful and diamonds are not and on the law of diminishing marginal utility. There is so much more water relative to diamonds that the next (additional) unit of water gives us less utility (lower marginal utility) than the next unit of diamonds.

When would a good's total utility and marginal utility be the same?

The total and marginal utilities of a good are the same for the first unit of the good consumed. For example, before Tomas eats his first apple, he receives no utility or disutility from apples. Eating the first apple, he receives 15 utils. So the total utility (TU) for 1 apple is 15 utils, and the marginal utility (MU) for the first apple is 15 utils. Exhibit 1 shows that TU and MU are the same for the first unit of good X.

Brandon's grandmother is very cautious about spending money. Yesterday, she gave Brandon a gift of $100 for his birthday. Brandon also received a gift of $100 from his father, who isn't nearly as cautious about spending money as Brandon's grandmother. Brandon believes that buying frivolous things with his grandmother's gift would be wrong, but not with his father's gift. Is Brandon compartmentalizing? Explain your answer.

Yes, Brandon is compartmentalizing. He is treating the $100 that comes from his grandmother differently from the $100 that comes from his father.