MICRO - MOD 6 - CH 7 - HW

Suppose that Omar's marginal utility for cups of coffee is constant at 1.5 utils per cup no matter how many cups he drinks. In contrast, his marginal utility per doughnut is 10 for the first doughnut he eats, 9 for the second, 8 for the third, and so on (that is, declining by 1 util per additional doughnut). In addition, suppose that coffee costs $1 per cup, doughnuts cost $1 each, and Omar has a budget that he can spend only on doughnuts, coffee, or both. How big would that budget have to be before he will spend a dollar buying a first cup of coffee? Instructions: Enter your answer as a whole number. a) $10 correct Explanation To answer this question, we first need to calculate the marginal utility per dollar for doughnuts. Recall that the marginal utility per dollar for a good is the marginal utility divided by the price of the good (= MU/P). For the first doughnut, we have 10 (= 10/$1). The second doughnut is 9 (= 9/$1). For the third 8, fourth 7, fifth 6, sixth 5, seventh 4, eighth 3, ninth 2, and tenth 1. The marginal utility per dollar for every cup of coffee is 1.5 (= 1.5/$1). To determine how big the budget would have to be before Omar would spend a dollar buying his first cup of coffee, we compare the marginal utility per dollar values. Omar will purchase the first doughnut before he buys a cup of coffee because the marginal utility per dollar for the doughnut is greater than the marginal utility per dollar for the cup of coffee (10 > 1.5). The same is true for the second through the ninth doughnut. This implies Omar will buy 9 doughnuts at a price of $1 each before he buys his first cup of coffee. Therefore, his budget will need to be $10 before he buys his first cup of coffee, $9 for doughnuts and $1 for the cup of coffee.

$10

Rank each of the following three gift possibilities in terms of how much utility they are likely to generate(with 1 being the highest and 3 being the lowest). Rank the options below: 1) A store-specific gift card worth $15 - Choice 2 of 3 = Correct 2) A $15 item from a specific store - Choice 3 of 3 = Correct 3) $15 cash that can be spent anywhere - Choice 1 of 3 Correct Explanation From the highest to lowest likely utility, we would rank the options as follows: Cash, gift card, specific item. Even though the price of each option is the same, we don't know how the recipient will value them as such. The $15 specific item may not be something the recipient likes, meaning he may value it less than $15. The gift card may be for a store that the recipient won't like, but it gives him the flexibility to select the item. The cash gives him the ability to select how the money is spent, and he can therefore purchase the item he values the most. The more say that the recipient has on how the money is spent, the more likely the option will have a higher utility.

1) $15 cash that can be spent anywhere 2) A store-specific gift card worth $15 - Choice 2 of 3 = Correct 3) A $15 item from a specific store - Choice 3 of 3 = Correct

True or False: The law of diminishing marginal utility predicts the consumption behavior of drug addicts quite well. False Correct Explanation False: The law of diminishing marginal utility does not predict the consumption behavior of addicts well at all. That is because the law predicts that, other things equal, successive units will be less and less valuable to a person. Thus, people should not keep on consuming additional units relentlessly. But an alcoholic, for instance, will often pursue a 15th drink on a given day with as much intensity as he pursued his first drink that day. And a gambling addict will often bet his final dollar with as much alacrity as he bet his first. Those suffering from addiction appear to behave as if the marginal utility of the drug or behavior to which they are addicted remains high no matter how much of the drug or behavior they engage in.

False

Demand curves slope downward because other things equal, multiple choice an increase in a product's price lowers MU. an increase in a product's price raises MU per dollar and makes consumers wish to purchase more units. a decrease in a product's price lowers MU. a decrease in a product's price raises MU per dollar and makes consumers wish to purchase more units. Correct Explanation Rational consumers decide how to spend their limited budgets by comparing the marginal utilities per dollar that they can get from various products. If the prices of all other products stay the same while the price of product X falls, then the MU per dollar of money spent on product X will increase. That will mean that any money spent purchasing units of product X will get the consumer more MU than previously. Thus, consumers interested in getting as much utility as possible when spending their limited budgets will want to spend more of their limited budgets on product X. This behavior explains the downward slope of demand curves because a decrease in the price of product X leads to an increase in the quantity demanded of product X.

a decrease in a product's price raises MU per dollar and makes consumers wish to purchase more units.

John likes Coca-Cola. After consuming one Coke, John has a total utility of 10 utils. After two Cokes, he has a total utility of 25 utils. After three Cokes, he has a total utility of 50 utils. a. Does John show diminishing marginal utility for Coke, or does he show increasing marginal utility for Coke? multiple choice 1 Diminishing marginal utility Increasing marginal utility Correct b. Suppose that John has $3 in his pocket. If Cokes cost $1 each and John is willing to spend one of his dollars on purchasing a first can of Coke, would he spend his second dollar on a Coke, too? multiple choice 2 Yes Correct No c. What about the third dollar? multiple choice 3 Yes Correct No d. If John's marginal utility for Coke keeps on increasing no matter how many Cokes he drinks, would it be fair to say that he is addicted to Coke? multiple choice 4 No Yes Correct Explanation a. John's marginal utility equals the change in total utility as he consumes an additional unit. Thus, his marginal utility from the first Coke is 10 (= 10 − 0). The marginal utility from his second Coke is 15 (= 25 − 10), and the marginal utility from his third Coke is 25 (= 50 − 25). Since his marginal utility is increasing at an increasing rate, he shows increasing marginal utility for Coke. b. If John consumes the first can of Coke, we know that his marginal utility per dollar was sufficient to induce the purchase. Since his marginal utility increases as he consumes more Coke, his marginal utility per dollar will also increase (price does not change). This implies that he will purchase the second Coke because it provides even more marginal utility per dollar than the first Coke did. c. The same is true for the third can of Coke. d. He will spend his entire income on Coke; thus, it is fair to say he is addicted to Coke.

a) Increasing marginal utility b) yes c) yes d) yes

Mrs. Simpson buys loaves of bread and quarts of milk each week at prices of $1 and 80 cents, respectively. At per-cent she is buying these products in amounts such that the marginal utilities from the last units purchased of the two products are 80 and 70 utils, respectively. a) Is she buying the utility-maximizing combination of bread and milk? multiple choice A. No, the marginal utility per-cent spent on bread is 0.80 and the marginal utility per-cent spent on milk is 0.875. Correct B. No, the marginal utility per-cent spent on bread is 0.875 and the marginal utility per-cent spent on milk is 0.80. C. She may or may not be buying the utility-maximizing combination since the amount that she is purchasing is not given. D. We cannot determine the utility-maximizing combination of bread and milk from the given information. b) If not, how should she reallocate her expenditures between the two goods? multiple choice A. She should buy more milk and less bread. Correct B. She should buy less milk and more bread. C. She should buy more bread and more milk. D. She is currently buying the utility-maximizing combination of bread and milk. Explanation a) Mrs. Simpson is not buying the utility-maximizing combination of bread and milk because the marginal utility per cent spent on each good is not equal. The marginal utility per-cent of bread is 0.80 (= 80 utils/100 cents); the utility per-cent of milk is 0.875 (= 70 utils/80 cents). b) Mrs. Simpson should buy more milk and less bread.

a) No, the marginal utility per-cent spent on bread is 0.80 and the marginal utility per-cent spent on milk is 0.875. b) She should buy more milk and less bread.

Explain: a) ''It is irrational for an individual to take the time to be completely rational in economic decision-making. ''This statement recognizes that multiple choice A. time has less value than money. B. wise consumers spend a great deal of time in decision making. C. it would take a great deal of time to consider all the factors of every decision. Correct D. most consumers are not rational. b) "Telling your spouse the name of the restaurant where you would like to eat for your birthday makes sense in terms of utility maximization." This statement recognizes that multiple choice A. the benefit of making the request will likely exceed the cost. Correct B. utility varies among consumers. C. eating out has its own utility. D. it is irrational to make such a request. Explanation a) To be completely rational in economic decision-making, provided one does not take time into consideration, one has to take account of every factor. This would make a great deal of time. One could not, for example, make any purchase without first searching the Internet to see whether a better deal could be had, rather than simply heading for the nearest store. However, this would be most irrational, for time does have value. While making an extensive search before making any deal, one would be forgoing the income to make this or any deal. For every penny saved to make the perfect deal, one would be losing dollars in income because of the time spent in making the perfect deal. b) There is little time sacrificed in making a request to your spouse for the restaurant where you want to eat for your birthday. If you eat there, the benefit will likely exceed the cost. It also reduces the probability of eating at a restaurant where the market value (purchase price) exceeds the utility to the recipient.

a) it would take a great deal of time to consider all the factors of every decision b) the benefit of making the request will likely exceed the cost.

ADVANCED ANALYSIS A "mathematically fair bet" is one in which the amount won will on average equal the amount bet—for example, when a gambler bets $100 for a 10 percent chance to win $1,000 ($100 = 0.10 × $1,000). QUESTION: a) Assuming diminishing marginal utility of dollars, this is not a fair bet in terms of utility because multiple choice A. the amount you can gain exceeds the amount that you bet. the chance of winning the bet is too low. B. the utility of the $100 used to make the bet is greater than the $900 that you might gain if you win the bet. Correct C. the utility of the $100 used to make the bet is less than the $900 that you might gain if you win the bet. QUESTION: b) When the "house" takes a cut of each dollar bet, the bet is multiple choice A. unchanged in terms of fairness. B. fairer, because the "house" also makes some money. C. less fair, because the winnings are reduced. Correct D. less fair, because the chance of winning is reduced. Explanation a) Because the marginal utility of money diminishes the more you have, the utility of the $100 used to make the bet is greater than the $900 that you might gain ($1,000 − $100) if you win the bet. b) It is even less of a "fair bet" when the "house" takes its cut because the $100 bet has the possibility of yielding less than the $900 in winnings.

a) the utility of the $100 used to make the bet is greater than the $900 that you might gain if you win the bet. b) less fair, because the winnings are reduced.

Many apartment-complex owners are installing water meters for each apartment and billing the occupants according to the amount of water they use. This system contrasts with the former procedure of having a central meter for the entire complex and dividing up the collective water expense as part of the rent. Where individual meters have been installed, water usage has declined 10 to 40 percent. a) This decline in water usage multiple choice A. is the result of higher water rates passed by the city. B. would be expected since people now have to pay according to the amount of water they use. Correct C. will occur only in the short run, then people will return to their old habits. D. would have been expected only if the water use was initially metered. Explanation The way we pay for a good or service can significantly alter the amount purchased. An individual living in an apartment complex who paid a share of the water expense measured by a central meter would have little incentive to conserve. Individual restraint would not have much impact on the total amount of water used. Suppose there were 10 apartments in the complex, and each apartment would be billed for one-tenth of the cost of the water. A single gallon of water would carry a price equal to one-tenth the amount charged by the water district. The very low price per gallon would encourage the use of water until the marginal utility of an additional gallon was correspondingly low. If the tenants paid separately for their own water, the full market price of water would be considered when making their consumption choices.

a) would be expected since people now have to pay according to the amount of water they use.

Tammy spends her money on lemonade and iced tea. If the price of lemonade falls, it is as though her income _______. multiple choice: decreases. increases. Correct stays the same. term-6 Explanation Increases: A person's income is not the same thing as their budget. Rather their income is the amount of goods and services that they can purchase with their budget. Thus, when the price of something that they purchase falls, their income rises because they can now purchase more goods and services than they did before. Consider the following example. Suppose that Tammy originally has a $6 budget and maximizes utility by purchasing 2 glasses of lemonade for $2 each and 2 glasses of iced tea for $1 each. So her income of goods and services is 2 glasses of lemonade and 2 glasses of iced tea. Then suppose that the price of lemonade falls in half, to only $1 per glass. Her budget of $6 remains unchanged, but she will now be able to purchase more total items and thereby enjoy a higher income due to the lower price of lemonade. This can be seen most directly by noting that her old income of 2 glasses of lemonade and 2 glasses of iced tea will now only cost $4, which means that she has $2 left over to increase her consumption of either iced tea or lemonade. The price reduction allows her to consume more overall, which is the same as saying that her income of goods and services has increased.

increases