Consumer choice:
What is a Giffen good?
A Giffen good is something consumers buy more of when its price rises and buy less of when its price falls.
You participate in a taste test for a new protein supplement called "Boost." You are given five consecutive one ounce vials of the supplement and after consuming each vial you are asked to note your reaction. You consume the first vial and your response is: "Hmmm, quite good!" After the second, you say, "Not bad at all." After the third, you note, "It's alright." and after the fourth you wince, "No more, the after-taste is getting to me. I need water." What economic principle does this scenario illustrate? Define the principle.
It illustrates the law of diminishing marginal utility which states that consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time.
What is marginal utility and what is the law of diminishing marginal utility?
Marginal utility is the change in total satisfaction a person receives from consuming one additional unit of a good or service. The law of diminishing marginal utility is the principle that consumers experience diminishing additional satisfaction as they consume more of a good or service
Describe the demand curve for a Giffen good.
The demand curve for a Giffen good slopes upward, indicating that the quantity demanded increases when the price increases, and the quantity demanded falls when the price decreases.
What did economists Robert Jensen and Nolan Miller determine must be true for a good to be a Giffen good, where the income effect is larger than its substitution effect?
The good must be an inferior good and it must make up a very large portion of consumer's budgets.
What must be true in terms of the income effect, the substitution effect, and the type of good for the good's demand curve to be upward sloping?
The income effect would have to be larger than the substitution effect, and the good would have to be an inferior good
The increase in consumption of a good when its price falls is caused by two effects. What are these two effects? Explain the difference between these effects.
The two effects are the substitution and income effects. According to the substitution effect, more is consumed when the price of a good falls because the price of the good in question is now lower relative to the prices of other goods. In addition, the fall in price increases the consumer's purchasing power causing the quantity demanded to increase for a normal good and decrease for an inferior good. This is the income effect. For most goods, the income effect is small relative to the substitution effect which is why the overall effect of a price decrease is an increase in quantity demanded.
You wish to buy only one CD. Use the rule of equal marginal utility per dollar to determine which one to purchase: (a) Usher's latest CD for $15 which gives you 75 units of utility, or (b) Tom Petty and the Heartbreakers' Greatest Hits for $10 that gives you 100 units of utility?
You should buy the Tom Petty CD because the MU per dollar is 10 while MU per dollar for the Usher CD is only 5.
After getting an A on your economics exam, you decide to go to your favorite Mexican restaurant to celebrate. You are having trouble deciding whether to order the chipotle chicken chimichanga or the cilantro seafood enchiladas. Use the rule of equal marginal utility per dollar to determine which one to purchase: (a) the chimichanga for $8 which gives you 120 units of utility, or (b) the enchiladas for $15 which gives you 195 units of utility?
You should buy the chimichanga because the MU per dollar is 15 while MU per dollar for the enchiladas is only 13.
The Wong family consumes 3 pounds of fish and 5 pounds of chicken per month. The price of fish is $8 per pound and chicken is $4 per pound. a. What is the amount of income allocated to fish and chicken consumption? b. What is the price ratio (the price of fish relative to the price of chicken)? c. Explain the meaning of the price ratio you computed. d. If the Wongs maximize utility, what is the ratio of the marginal utility of fish to the marginal utility of chicken? e. If the price of chicken rises, will the Wong family consume more chicken, less chicken or the same amount of chicken? Explain your answer using the rule of equal marginal utility per dollar.
a. Income = $44 b. Price of fish / price of chicken = $8 / $4 = 2 c. To buy a pound of fish the family has to give up 2 pounds of chicken. d. MUfish / MUchicken = Price of fish / Price of chicken = $8 / $4 = 2 e. If the price of chicken rises, the marginal utilities per dollar will not be equal. Specifically, MUfish / Price fish > MUchicken / Price chicken. The family can raise its total utility by buying less chicken and
Eliza consumes 12 cappuccinos and 8 apple turnovers per week. The price of cappuccino is $4 each and apple turnovers are $1 each. a. What is the amount of income allocated to cappuccino and apple turnover consumption? b. What is the price ratio (the price of cappuccino relative to the price of apple turnovers)? c. Explain the meaning of the price ratio you computed. d. If Eliza maximize utility, what is the ratio of the marginal utility of cappuccino to the marginal utility of apple turnovers? e. If the price of apple turnovers falls, will Eliza consume more apple turnovers, fewer apple turnovers or the same amount of apple turnovers? Explain your answer using the rule of equal marginal utility per dollar.
a. Income = $56 b. Price of cappuccino / price of apple turnovers = $4 / $1 = 4 c. To buy a cappuccino, Eliza has to give up 4 apple turnovers. d. MUcappuccino / MUapple turnovers = Price of cappuccino/Price of apple turnovers = e. If the price of apple turnovers falls, the marginal utilities per dollar will not be equal. Specifically, MUcappuccino / Price cappuccino < MUapple turnovers / Price apple turnovers. Eliza can raise her total utility by buying more apple turnovers and less cappuccino.