ECON1101: Week 6 Tutorial 5

7/30/2019 ECON1101: Week 6 Tutorial 5

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Chapter 5 Demand: the benefit side of the market

Answers to review questions

1 To say that someone needs a good is to suggest that they cannot choose to do without

the good or buy a substitute for it. We are more likely to be mindful of the fact thatalmost all goods have substitutes if we speak of wants rather than needs.

2 Even though we cannot actually measure utility directly, the marginal utility modelhelps us to gain a better understanding of how a rational consumer would allocate theirincome among different goods.

3 The law of diminishing marginal utility says that the first units we consume of a gooddeliver the highest bang for ourbuck. This means that we can generally achievehigher total utility by spreading our incomes over many goods than by concentratingthem on only a few.

4 A scarce good must be rationed in one way or another. If its monetary price is zero,people will either have to wait in line for it, as in the free sausage example, or pay abribe, or incur some other cost to gain access to it.

5 Many people report that they didnt like spicy food the first time they ate it, or didntlike a certain comedian the first time they heard them. However, after repeatedexposures they often find that they like these experiences more and more. Also,depending on the nature of their condition, some people might derive greater benefitfrom their second visit within a month to an osteopath than they do from their first.

6 When people are charged for water on the basis of how much they use, they willrespond to an increase in its price in the same way that they would to an increase in the

price of any other good. In particular, they will find ways of conserving water, byreusing and recycling and by adopting water-saving devices and production methods.

7 When supply increases the price of a good falls and consumer surplus increases for tworeasons. The first reason is that buyers who were previously purchasing the good at ahigher price now enjoy a greater surplus. The second reason is that when the price of agood falls, more of it is sold; the additional units sold (except for the last one, for which

price exactly equals the buyers reservation price) have a positive consumer surplus.


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Answers to problems

1 Because willingness to pay for food quality is likely to be an increasing function ofincome, we expect the patrons of the gourmet restaurant to have higher incomes, onaverage, than the patron of the inexpensive cafe. And since willingness to pay for

service is also likely to be an increasing function of income, we expect the service inthe gourmet restaurant to be of a higher quality as well. Since restaurant patrons tend toleave tips of about 15 per cent of the price of their meals, they do, in fact, pay for andreceive higher quality of service.

2 Since the marginal cost of an additional morsel of food is zero, a rational person willcontinue eating until the marginal benefit of the last morsel (its marginal utility) falls tozero.

3 Maryanne is currently receiving (75 utils/glass)/($2.50/glass) = 30 utils per dollar fromher last dollar spent on orange juice, but only (50 utils/cup)/($2.00 /cup) = 25 utils perdollar from her last dollar spent on coffee. Since the two are not equal, she is not

maximising her utility. She should spend more on orange juice and less on coffee.4 Toby is currently receiving (100 utils/gram)/($0.10/gram) = 1000 utils per dollar from his

last dollar spent on peanuts, and (200 utils/gram)/($0.25/gram) = 800 utils per dollarfrom his last dollar spent on cashews. Since the two are not equal, he is not maximisinghis utility. He should spend more on cashews and less on peanuts.

5 The information given enables us to conclude that Sues average utility per dollar is thesame for both pizza and yoghurt. However, this information does not enable us to saywhether her current combination of the two goods is optimal. To do that, we must beable to compare the values of marginal utility per dollar for the two goods.

6 a Even at twice the original price, the marginal utility per dollar of the 20th

train trip may be higher than the corresponding ratio for any other good that Annmight consume, in which case she would be perfectly rational not to alter thenumber of trips she takes. After all, missing a trip would mean missing a wholedays work.

b The higher price of train tickets makes Ann poorer. The income effect of the priceincrease is what leads to the reduction in the number of restaurant meals she eats.

7 Consumer surplus is the area of the shaded triangle:

(1/2)bh = (1/2) (80 000 litres/year) ($8/litre)= $320 000/year.


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8 When the price of a slice of pizza is $6 and the price of a DVD rental is $3, theaffordable combinations and their corresponding utilities are as listed in the table,which shows that the optimal combination is three pizza slices per week and two movierentals.

Combinations of pizza and DVD rentals that cost $24 per week Total utility

8 rentals, 0 pizza slices 57 + 0 = 57





9 a The market demand curve (right panel) is the horizontal summation of the twoindividual demand curves (left and centre panels). For example, when the price ofa ticket is $24, the first consumer will not want to buy any tickets while thesecond consumer wants to buy 16 tickets.


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24

96tickets/yr

Price($/ticket)

48

36

Price($/ticket)

tickets/yr144

tickets/yr

Price($/ticket)36

2424

12 12

16 16

12

80

b Total consumer surplus is the sum of the three shaded areas:

Area of small triangle:

(1/2)bh = (1/2) (16 tickets/yr) ($12/ticket) = $96/yr

Area of rectangle:

bh = (16 tickets/yr) ($12/ticket) = $192/yr

Area of large triangle:

(1/2)bh = (64 tickets/yr) ($12/ticket) = $768/yr

Total consumer surplus:

$96/yr + $192/yr + $768/yr = $1056/yr

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ECON1101: Week 6 Tutorial 5