Answers to Questions from Chapter 5

Answers to Questions from Chapter 5 (1) and (2) The total utility of 22 gallons is greater than the total utility of 14 gallons. Total utility should rise as consumption increases. However, the marginal utility of 14 gallons is greater than the marginal utility of 22 gallons, because of the law of diminishing marginal utility. (3) Normal goods: a and d. Inferior goods: b and c. (4) Since the $700 air conditioner saves Emily $250 in cleaning costs, the opportunity cost of the air conditioner is only $450. (5) You must make up your own numbers for this question. Hints: total utility should rise as consumption increases and marginal utility should fall. Also, total utility must equal the sum of marginal utility. You should pick one marginal utility figure that is equal to the market price. There are numerous correct answers for this question. Here’s one example: Baskets 0 1 2 3 4 Total Utility 0 4 7 9 10 Marginal Utility --------4 3 2 1 Jim will buy two baskets, where marginal utility is equal to the market price for strawberries. (6) Total consumers surplus from Jim’s optimal purchase is $1.00. Graphically, consumer surplus is the area under the demand (or MU) curve and above the price. Calculate consumer surplus as the sum of net marginal utility or as the difference between total utility and total expenditure. Answers to Questions from Chapter 6 “Test Yourself” Questions (2) a. The demand for airline trips would shift outward. b. The demand for automobiles would shift outward. c. The demand for automobiles would shift inward. d. Demand will decrease (shift inward) in Maine to heat houses in the winter and demand will rise (shift outward) in Florida to cool houses in the summer. The rise in temperature is unlikely to affect air conditioning in Maine or home heating in Florida. (5) ∆QD 15,000 average of 2 quantities 17,500 .857 = = = 3.86 ∆P 5 .222 average of 2 prices 22.5 “Discussion Questions” (3) As we move down along a straight-line demand curve, the average quantity is rising while the average price is falling. This reduces the price elasticity of demand. (4) Total revenue is price times quantity. When the demand curve is elastic, the percentage decline in quantity demanded is greater than the percentage rise in price. Thus, the product of the two (total revenue) falls. remember: ε= % ∆Q D , if this fraction is >1 then: % ∆Q D > % ∆P. % ∆P (6) If demand is inelastic, then a price increase will raise total revenue. Moreover, the reduction in quantity should lower the total costs of the firm. Profits (TR - TC) will rise. 2