Chapter 5: demand and the rational consumer
If the market price is $30, then Claudia's buyer's surplus is → $5 If the market price is $30, then Darren's buyer's surplus is → $0
$5 $0
Several students are discussing the concept of price elasticity while standing in line at the campus bookstore. Which of the following quotations describes a price inelastic demand for a product? (overall spending is the same as expenditures)
A price increase really scares me. It wouldn't reduce my purchases of school supplies very much, but I know for sure that I'll end up spending a lot more than I was before.
Any consumer trying to decide whether to buy a given good or service will base the decision on his or her reservation price and the existing market price. (The highest price that a consumer is willing to pay for a product is known as the reservation price. Market price is the price that is actually paid by the consumer. Consumers will not purchase any product if their reservation price is lower than the market price. Therefore, the consumers will only purchase a product if their reservation price is higher than or equal to the market price.) When making this decision, the buyer's reservation price measures the marginal benefit: what the buyer is willing to pay The market price measures the marginal cost: the amount the buyer will actually have to pay The consumer will purchase the good or service only if the buyer's reservation price is equal to or higher than the market price Which of the following factors would impact a buyer's reservation price for a given good or service? Peer influence Peer influence provides an example of how social forces often influence demand; it is often the most important single determinant of demand. A change in the price moves the consumer along the demand curve and does not affect reservation price. A change in cost is a supply-side influence that will shift supply and not affect reservation price. You are having lunch at an all-you-can-eat buffet. If you are rational, what should be your marginal utility from the last morsel of food you swallow? Marginal utility from the last morsel of food you swallow should be zero The marginal cost of an additional morsel of food is zero at an all-you-can-eat buffet. Thus, applying the rational spending rule, a rational person will continue eating until the marginal utility of the last morsel falls to zero. Martha's current marginal utility from consuming orange juice is 75 utils per ounce and her marginal utility from consuming coffee is 50 utils per ounce. If orange juice costs 25 cents per ounce and coffee costs 20 cents per ounce, is Martha maximizing her total utility from the two beverages? At her current level of consumption, Martha is receiving: 300 utils per dollar spent on orange juice. At her current level of consumption, Martha is receiving 250 utils per dollar spent on coffee. Therefore, Martha is not maximizing her total utility because MUoj/Poj is not equal to MUc/Pc. At her current level of consumption, Martha receives (75 utils per ounce)/($0.25 per ounce) = 300 utils per dollar spent on orange juice, and she receives (50 utils per ounce)/($0.20 per ounce) = 250 utils per dollar spent on coffee. Since the two are not equal, she is not maximizing her utility. Given that she receives more utils per dollar spent on orange juice than on coffee, she should spend more on orange juice and less on coffee. Toby's current marginal utility from consuming peanuts is 100 utils per ounce and his marginal utility from consuming cashews is 200 utils per ounce. If peanuts cost 10 cents per ounce and cashews cost 25 cents per ounce, is Toby maximizing his total utility from the kinds of nuts? At current levels of peanut consumption, Toby receives 1,000 utils per dollar. At current levels of cashew consumption, Toby receives: 800 utils per dollar. Therefore, Toby is not maximizing his total utility because MUp/Pp is not equal to MUc/Pc. Sue gets a total of 20 utils per week from her consumption of pizza and a total of 40 utils per week from her consumption of yogurt. The price of pizza is $1 per slice, the price of yogurt is $1 per cup, and she consumes 10 slices of pizza and 20 cups of yogurt each week. Which of the following statements is correct regarding Sue's current consumption of pizza and yogurt? We cannot determine if Sue is maximizing her total utility with the information provided We must apply the rational spending rule to find out if Sue's current combination of pizza and yogurt is optimal. To do this, we need to know the marginal utility per dollar that Sue receives from each good; in other words, how much utility she gained from the last dollar spent on pizza and from the last dollar spent on yogurt. However, the information given only enables us to conclude that Sue's average utility per dollar is the same for both pizza and yogurt. We do not have enough information to know whether her marginal utility per dollar is the same for both goods. Tom has a weekly allowance of $24, all of which he spends on pizza and movie rentals, whose prices are $6 per slice and $3 per rental, respectively. We can assume that pizza slices and movie rentals are available only in whole-number amounts. For the given levels of pizza consumption, calculate how many rentals Tom can afford with his remaining income. Using the utility values in the table below, how many pizza slices and how many movie rentals should Tom consume each week to maximize his total utility? The buyers' side of the market for amusement park tickets consists of two consumers whose demand curves are shown in the diagram below Graph the market demand curve for this market. Calculate the total consumer surplus in the amusement park market if tickets sell for $12 each. $ 672 per year. For the demand curve shown, find the total amount of consumer surplus that results in the gasoline market if gasoline sells for $14 per gallon. For the demand curve shown, find the total amount of consumer surplus that results in the gasoline market if gasoline sells for $14 per gallon. Consumer surplus: $ 20,000 per year. 1/2 (base) x (height) = 1/2 (10,000 gallons/ year) x ($4/ gal) = $20,000 per year Refer to the accompanying figure. Suppose a consumer protection group convinces the government to impose price controls in this market. If the government requires cheese to be sold for less than the equilibrium price, then, relative to before the price controls, total consumer surplus in the market: Could either increase or decrease. If a price control were set below the equilibrium price, then this would lower the price that consumers paid for each pound of cheese, but, at a lower price, fewer pounds of cheese would be sold due to the reduction in quantity supplied. Thus, consumer surplus could either increase or decrease. Refer to the accompanying figure. What is total consumer surplus at the market equilibrium? $80 per day Consumer surplus is the area of the triangle below the demand curve and above the equilibrium price. The area of any triangle is equal to ½(b × h), where b = base and h = height. So here, consumer surplus is equal to ½(40 × 4) = $80. If marginal utility is positive, then as consumption increases: Total utility will increase If marginal utility is positive, then total utility will increase as consumption increases. Refer to the accompanying figure. Suppose the dairy lobby convinces the government to impose price controls in this market. If the government requires cheese to be sold for a price of $8 per pound, then, relative to before the price controls, total consumer surplus in the market would: Decrease Consumer surplus is the area of the triangle below the demand curve and above price. The area of any triangle is equal to ½(b × h), where b = base and h = height. So here, if the government requires cheese to be sold for $8 per pound, consumer surplus would equal ½(20 × 2) = $20. Note that this is less than consumer surplus at the market equilibrium price of $6 per pound. Refer to the accompanying figure. Suppose the dairy lobby convinces the government to impose price controls in this market. If the government requires cheese to be sold for a price of $8 per pound, total consumer surplus in the market would equal: $20 per day Consumer surplus is the area of the triangle below the demand curve and above price. The area of any triangle is equal to ½(b × h), where b = base and h = height. So here, if the government requires cheese to be sold for $8 per pound, consumer surplus would equal ½(20 × 2) = $20. Note that this is less than consumer surplus at the market equilibrium price of $6 per pound.
Any consumer trying to decide whether to buy a given good or service will base the decision on his or her reservation price and the existing market price. (The highest price that a consumer is willing to pay for a product is known as the reservation price. Market price is the price that is actually paid by the consumer. Consumers will not purchase any product if their reservation price is lower than the market price. Therefore, the consumers will only purchase a product if their reservation price is higher than or equal to the market price.) When making this decision, the buyer's reservation price measures the marginal benefit: what the buyer is willing to pay The market price measures the marginal cost: the amount the buyer will actually have to pay The consumer will purchase the good or service only if the buyer's reservation price is equal to or higher than the market price Which of the following factors would impact a buyer's reservation price for a given good or service? Peer influence Peer influence provides an example of how social forces often influence demand; it is often the most important single determinant of demand. A change in the price moves the consumer along the demand curve and does not affect reservation price. A change in cost is a supply-side influence that will shift supply and not affect reservation price. You are having lunch at an all-you-can-eat buffet. If you are rational, what should be your marginal utility from the last morsel of food you swallow? Marginal utility from the last morsel of food you swallow should be zero The marginal cost of an additional morsel of food is zero at an all-you-can-eat buffet. Thus, applying the rational spending rule, a rational person will continue eating until the marginal utility of the last morsel falls to zero. Martha's current marginal utility from consuming orange juice is 75 utils per ounce and her marginal utility from consuming coffee is 50 utils per ounce. If orange juice costs 25 cents per ounce and coffee costs 20 cents per ounce, is Martha maximizing her total utility from the two beverages? At her current level of consumption, Martha is receiving: 300 utils per dollar spent on orange juice. At her current level of consumption, Martha is receiving 250 utils per dollar spent on coffee. Therefore, Martha is not maximizing her total utility because MUoj/Poj is not equal to MUc/Pc. At her current level of consumption, Martha receives (75 utils per ounce)/($0.25 per ounce) = 300 utils per dollar spent on orange juice, and she receives (50 utils per ounce)/($0.20 per ounce) = 250 utils per dollar spent on coffee. Since the two are not equal, she is not maximizing her utility. Given that she receives more utils per dollar spent on orange juice than on coffee, she should spend more on orange juice and less on coffee. Toby's current marginal utility from consuming peanuts is 100 utils per ounce and his marginal utility from consuming cashews is 200 utils per ounce. If peanuts cost 10 cents per ounce and cashews cost 25 cents per ounce, is Toby maximizing his total utility from the kinds of nuts? At current levels of peanut consumption, Toby receives 1,000 utils per dollar. At current levels of cashew consumption, Toby receives: 800 utils per dollar. Therefore, Toby is not maximizing his total utility because MUp/Pp is not equal to MUc/Pc. Sue gets a total of 20 utils per week from her consumption of pizza and a total of 40 utils per week from her consumption of yogurt. The price of pizza is $1 per slice, the price of yogurt is $1 per cup, and she consumes 10 slices of pizza and 20 cups of yogurt each week. Which of the following statements is correct regarding Sue's current consumption of pizza and yogurt? We cannot determine if Sue is maximizing her total utility with the information provided We must apply the rational spending rule to find out if Sue's current combination of pizza and yogurt is optimal. To do this, we need to know the marginal utility per dollar that Sue receives from each good; in other words, how much utility she gained from the last dollar spent on pizza and from the last dollar spent on yogurt. However, the information given only enables us to conclude that Sue's average utility per dollar is the same for both pizza and yogurt. We do not have enough information to know whether her marginal utility per dollar is the same for both goods. Tom has a weekly allowance of $24, all of which he spends on pizza and movie rentals, whose prices are $6 per slice and $3 per rental, respectively. We can assume that pizza slices and movie rentals are available only in whole-number amounts. For the given levels of pizza consumption, calculate how many rentals Tom can afford with his remaining income. Using the utility values in the table below, how many pizza slices and how many movie rentals should Tom consume each week to maximize his total utility? The buyers' side of the market for amusement park tickets consists of two consumers whose demand curves are shown in the diagram below Graph the market demand curve for this market. Calculate the total consumer surplus in the amusement park market if tickets sell for $12 each. $ 672 per year. For the demand curve shown, find the total amount of consumer surplus that results in the gasoline market if gasoline sells for $14 per gallon. For the demand curve shown, find the total amount of consumer surplus that results in the gasoline market if gasoline sells for $14 per gallon. Consumer surplus: $ 20,000 per year. 1/2 (base) x (height) = 1/2 (10,000 gallons/ year) x ($4/ gal) = $20,000 per year Refer to the accompanying figure. Suppose a consumer protection group convinces the government to impose price controls in this market. If the government requires cheese to be sold for less than the equilibrium price, then, relative to before the price controls, total consumer surplus in the market: Could either increase or decrease. If a price control were set below the equilibrium price, then this would lower the price that consumers paid for each pound of cheese, but, at a lower price, fewer pounds of cheese would be sold due to the reduction in quantity supplied. Thus, consumer surplus could either increase or decrease. Refer to the accompanying figure. What is total consumer surplus at the market equilibrium? $80 per day Consumer surplus is the area of the triangle below the demand curve and above the equilibrium price. The area of any triangle is equal to ½(b × h), where b = base and h = height. So here, consumer surplus is equal to ½(40 × 4) = $80. If marginal utility is positive, then as consumption increases: Total utility will increase If marginal utility is positive, then total utility will increase as consumption increases. Refer to the accompanying figure. Suppose the dairy lobby convinces the government to impose price controls in this market. If the government requires cheese to be sold for a price of $8 per pound, then, relative to before the price controls, total consumer surplus in the market would: Decrease Consumer surplus is the area of the triangle below the demand curve and above price. The area of any triangle is equal to ½(b × h), where b = base and h = height. So here, if the government requires cheese to be sold for $8 per pound, consumer surplus would equal ½(20 × 2) = $20. Note that this is less than consumer surplus at the market equilibrium price of $6 per pound. Refer to the accompanying figure. Suppose the dairy lobby convinces the government to impose price controls in this market. If the government requires cheese to be sold for a price of $8 per pound, total consumer surplus in the market would equal: $20 per day Consumer surplus is the area of the triangle below the demand curve and above price. The area of any triangle is equal to ½(b × h), where b = base and h = height. So here, if the government requires cheese to be sold for $8 per pound, consumer surplus would equal ½(20 × 2) = $20. Note that this is less than consumer surplus at the market equilibrium price of $6 per pound.
Economics in action
Buying your way out of temptation
When are people willing to pay higher prices for Christmas presents, on December 24 or on September 24? Why?
On December 24, because their demand for presents is highly price-inelastic on that day.
For questions 8 and 9 consider the following table with cross- price elasticities According to this table, which of the pairs above are complements? SUVs and gasoline. According to the table above, how does a 10% decrease in the price of gasoline affect the quantity of SUVs demanded? The quantity demanded of SUVs goes up by 2.8% (= 0.28 * 10%).
SUVs and gasoline. The quantity demanded of SUVs goes up by 2.8% (= 0.28 * 10%).
Quiz 7: The publisher of a national newspaper recently lowered the price of the newspaper by 5%. The newspaper sold 10% more issues. The publisher was quoted saying, "the 5% decrease in price generated an increase in revenues." Which of the following statements best describes an economist's reaction to the publisher's claim:
The implied price elasticity of demand for the newspaper is 2 (=10/5), and the increased revenue claim is quite possibly true.
The publisher of a national newspaper recently lowered the price of the newspaper by 5%. The newspaper sold 10% more issues. The publisher was quoted saying, "the 5% decrease in price generated an increase in revenues." Which of the following statements best describes an economist's reaction to the publisher's claim:
The implied price elasticity of demand for the newspaper is 2 (=10/5), and the increased revenue claim is quite possibly true.
The substitution effect of a price decrease is the increase in the quantity demanded that results because buyers switch away from using substitute goods The difference between a buyer's reservation price for a product and the price the buyer actually paid is known as consumer surplus The total amount that consumers would be willing to pay in the aggregate, for the right to participate in the market is total consumer surplus in the market Figure shows the relationship between the # of house of TV that Mike watches each day and his total utility. Mike's marginal utility of going from 1 - 2 hours of tv per day is about 2 utils per day Mikes marginal utility of going from 2 - 3 hours of tv per day is positive When Mike goes from watching 2-3 hours of tv per day, his total utility increases Suppose most people either fly or drive when they go on vacation. If airfare increases, then you would expect fewer people to fly and more people to drive The shift from the "original" to the "new" budget constraint is best explained by which of the following → an increase in income If the price of bananas decreases, then which of the following will occur → the vertical intercept will increase and the horizontal intercept will not change The dollar price of a good relative to the average dollar price of all other goods is the real of a good
The substitution effect of a price decrease is the increase in the quantity demanded that results because buyers switch away from using substitute goods The difference between a buyer's reservation price for a product and the price the buyer actually paid is known as consumer surplus The total amount that consumers would be willing to pay in the aggregate, for the right to participate in the market is total consumer surplus in the market Figure shows the relationship between the # of house of TV that Mike watches each day and his total utility. Mike's marginal utility of going from 1 - 2 hours of tv per day is about 2 utils per day Mikes marginal utility of going from 2 - 3 hours of tv per day is positive When Mike goes from watching 2-3 hours of tv per day, his total utility increases Suppose most people either fly or drive when they go on vacation. If airfare increases, then you would expect fewer people to fly and more people to drive The shift from the "original" to the "new" budget constraint is best explained by which of the following → an increase in income If the price of bananas decreases, then which of the following will occur → the vertical intercept will increase and the horizontal intercept will not change The dollar price of a good relative to the average dollar price of all other goods is the real of a good
Total utility refers to the total satisfaction people derive from their consumption activities According to the rational spending rule, spending should be allocated across goods so that the marginal utility per dollar is the same for each good When the price of a good goes up, part of the reason consumers purchase less of the good is that they switch to less expensive substitutes When sean consumes 1 popsicle per hour, his total utility is 100 utils per hour The additional utility gained from consuming an additional unit of a good is called marginal utility The law demand stats that people do less of what they want to do as the cost of doing something rises Once people have achieved bare subsistence levels of consumption, economics emphasize that we can talk mainly in terms of people's wants The affordable combination of goods that yields the highest total utility for a consumer is knows as the optimal combination of goods Economists assume that people allocate their incomes between different goods and services to make themselves as happy as possible The law of diminishing marginal utility captures the tendency for the additional utility gained from consuming an additional unit of good to diminish as consumption increases beyond some point The nominal price of a good is the absolute price of the good in dollar terms Which of the following best illustrates the substitution effect of a decrease in the price of pasta? The increase in the quantity of pasta demanded that results because people switch from eating rice to pasta
Total utility refers to the total satisfaction people derive from their consumption activities According to the rational spending rule, spending should be allocated across goods so that the marginal utility per dollar is the same for each good When the price of a good goes up, part of the reason consumers purchase less of the good is that they switch to less expensive substitutes When sean consumes 1 popsicle per hour, his total utility is 100 utils per hour The additional utility gained from consuming an additional unit of a good is called marginal utility The law demand stats that people do less of what they want to do as the cost of doing something rises Once people have achieved bare subsistence levels of consumption, economics emphasize that we can talk mainly in terms of people's wants The affordable combination of goods that yields the highest total utility for a consumer is knows as the optimal combination of goods Economists assume that people allocate their incomes between different goods and services to make themselves as happy as possible The law of diminishing marginal utility captures the tendency for the additional utility gained from consuming an additional unit of good to diminish as consumption increases beyond some point The nominal price of a good is the absolute price of the good in dollar terms Which of the following best illustrates the substitution effect of a decrease in the price of pasta? The increase in the quantity of pasta demanded that results because people switch from eating rice to pasta
The 1990 "yacht tax" caused a large loss in jobs and it collected less revenue than expected, because demand for luxury yachts made in the United States is
Very price-elastic
What can you conclude about the price elasticity of demand from this statement: "The pizza delivery business in this town is very competitive. I'd lose half of my customers if I raised the price by as little as 10%." Demand is
elastic (but not perfectly elastic).
Which data from the table on the worksheet can we derive a mini demand curve for which good
good B
Harry is spending all his income on milkshakes and french fries. At his current consumption levels the marginal utility for one milkshake and the marginal utility for one order of french fries are equal. According to the rational spending rule
harry is maximizing his utility only if 1 milkshake and 1 order of french fries have the same price
If the income elasticity of demand is negative, then the good is a
inferior good.
Quiz 7: if income elasticity of demand is positive, then the good is a
normal good
Economics in action
oyster versus chicken
What can you conclude about the price elasticity of demand from this statement: "My economics professor has chosen to use the Frank et al. textbook for this class. I have no choice but to buy this book, no matter what the price is." This student's demand for the Frank et al. textbook is, at least within a certain price range,
perfectly inelastic
Benny spends all his money buying wine and cheese. The marginal utility of the last bottle of wine is $60, and the marginal utility of the last block of cheese is 30. The price of wine is $3, and the price of cheese is $2. Note that 60/3 = 20 and 30/2 = 15. Benny
should buy more wine and less cheese
What does the principle of diminishing marginal utility imply for marginal utility (for most goods)
starting at some point, the marginal utility function is downward sloping
What does the principle of diminishing marginal utility imply for total utility (for most goods)
the total utility function is first upward sloping, but becoming less steep with an increase in units until eventually it might have a negative slope
Which statement about the previous comparison between oysters and chickens is correct
today, people consume less oysters than chickens, and therefore, marginal utility for oysters is larger than marginal utility for chickens
If the demand stays constant, but the price in a market falls, which of the following happens
total consumer surplus goes up
