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theory of choice
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The interaction of preferences and constraints that causes people to make the choices they do
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Utility
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The pleasure or satisfaction that people get from their economic activity.
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Explain why the slope of an indifference curve would not be expected to be positive for economic "goods."
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budget constraint
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The limit that income places on the combinations of goods that an individual can buy
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Suppose a person has $100 to spend on Frisbees and beach balls
. 1. Graph this person's budget constraint if Frisbees cost $20 and beach balls cost $10.
2. How would your graph change if this person decided to spend $200 (rather than $100) on these two items?
3. How would your graph change if Frisbee and beach ball prices doubled to $40 and $20, respectively, with total spending of $200?
. 1. Graph this person's budget constraint if Frisbees cost $20 and beach balls cost $10.
2. How would your graph change if this person decided to spend $200 (rather than $100) on these two items?
3. How would your graph change if Frisbee and beach ball prices doubled to $40 and $20, respectively, with total spending of $200?
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Simple utility maximization requires MRS ¼ PX =PY .
1. Why does the price ratio PX =PY show the rate at which any person can trade Y for X in "the market"? Illustrate this principle for the case of music CDs (which cost $10 each) and movie DVDs (which cost $17 each).
2. If an individual's current stock of CDs and DVDs yields him or her an MRS of 2 for 1 (that is, he or she is willing to trade two CDs for one DVD), how should consumption patterns be changed to increase utility?
1. Why does the price ratio PX =PY show the rate at which any person can trade Y for X in "the market"? Illustrate this principle for the case of music CDs (which cost $10 each) and movie DVDs (which cost $17 each).
2. If an individual's current stock of CDs and DVDs yields him or her an MRS of 2 for 1 (that is, he or she is willing to trade two CDs for one DVD), how should consumption patterns be changed to increase utility?
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Figures 2.8 and 2.9 show that the condition for utility maximization should be amended sometimes to deal with special situations.
1. Explain how the condition should be changed for "boundary" issues such as those shown in Figures 2.8(c) and 2.9(c), where people buy zero amounts of some goods. Use this to explain why your authors never buy any lima beans.
2. How do you interpret the utility-maximizing conditions when goods are perfect complements, such as those shown in Figure 2.9(d)? If left and right shoes were sold separately, would any price ratio make you depart from buying pairs?
1. Explain how the condition should be changed for "boundary" issues such as those shown in Figures 2.8(c) and 2.9(c), where people buy zero amounts of some goods. Use this to explain why your authors never buy any lima beans.
2. How do you interpret the utility-maximizing conditions when goods are perfect complements, such as those shown in Figure 2.9(d)? If left and right shoes were sold separately, would any price ratio make you depart from buying pairs?
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Suppose that the uncle's heirs had offered to settle by making Willie as well-off as he would have been by acting sinfully in his teenage years. In Figure 1, how could you show the amount they would have to pay? 2. Would the requirement that the uncle make Willie "whole" by paying the amount suggested in question 1 provide the right incentives for the uncle to stick to the original deal? (This is an example of how the choice of "damage rules" may affect the willingness of contracting parties to complete the deal.)
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Composite good
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Combining expenditures on several different goods whose relative prices do not change into a single good for convenience in analysis.
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Utility can be shown by
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an indifference curve map. Each indifference curve identifies those bundles of goods that a person considers to be equally attractive. Higher levels of utility are represented by higher indifference curve "contour" lines.
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The slope of indifference curves shows
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how a person is willing to trade one good for another while remaining equally well-off. The absolute value of this slope is called the "marginal rate of substitution" (MRS), because it shows the degree to which an individual is willing to substitute one good for another in his or her consumption choices. The value of this trade-off depends on the amount of the two goods being consumed.
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If people are to obtain the maximum possible utility from their limited incomes?
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they should spend all the available funds and should choose a bundle of goods for which the MRS is equal to the price ratio of the two goods. Such a utility maximum is shown graphically by a tangency between the budget constraint and the highest indifference curve that this person's income can buy.
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People are limited in what they can buy by their?
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"budget constraints." When a person is choosing between two goods, his or her budget constraint is usually a straight line because prices do not depend on how much is bought. The absolute value of the slope of this line represents the price ratio of the two goods—it shows what one of the goods is worth in terms of the other in the marketplace.
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The notion of utility is an "ordinal" one for which it is assumed that people can rank combinations of goods as to their desirability, but that they cannot assign a unique numerical (cardinal) scale for the goods that quantifies "how much" one combination is preferred to another. For each of the following ranking systems, describe whether an ordinal or a cardinal ranking is being used: (a) military or academic ranks; (b) prices of vintage wines; (c) rankings of vintage wines by the French Wine Society; (d) press rankings of the "Top Ten" football teams; (e) results of the U.S. Open Golf Championships (in which players are ranked by the number of strokes they take); (f) results of the NCAA basketball tournament (which is conducted using a draw that matches teams against one another until a final winner is found).
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How might you draw an indifference curve map that illustrates the following ideas?
a. Margarine is just as good as the high-priced spread.
b. Things go better with Coke.
c. A day without wine is like a day without sunshine.
d. Popcorn is addictive—the more you eat, the more you want.
e. It takes two to tango.
a. Margarine is just as good as the high-priced spread.
b. Things go better with Coke.
c. A day without wine is like a day without sunshine.
d. Popcorn is addictive—the more you eat, the more you want.
e. It takes two to tango.
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Inez reports that an extra banana would increase her utility by two units and an extra pear would increase her utility by six units. What is her MRS of bananas for pears—that is, how many bananas would she voluntarily give up to get an extra pear? Would Philip (who reports that an extra banana yields 100 units of utility, whereas an extra pear yields 400 units of utility) be willing to trade a pear to Inez at her voluntary MRS?
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. Oscar consumes two goods, wine and cheese. His weekly income is $500.
a. Describe Oscar's budget constraints under the following conditions:
i. Wine costs $10/bottle, cheese costs $5/pound;
ii. Wine costs $10/bottle, cheese costs $10/pound;
iii. Wine costs $20/bottle, cheese costs $10/pound;
iv. Wine costs $20/bottle, cheese costs $10/pound
a. Describe Oscar's budget constraints under the following conditions:
i. Wine costs $10/bottle, cheese costs $5/pound;
ii. Wine costs $10/bottle, cheese costs $10/pound;
iii. Wine costs $20/bottle, cheese costs $10/pound;
iv. Wine costs $20/bottle, cheese costs $10/pound
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Oscar consumes two goods, wine and cheese. His weekly income is $500.
b. Describe why budget constraints ii and iii will probably provide less utility than does budget constraint i. Are there any situations where this would not be the case?
i. Wine costs $10/bottle, cheese costs $5/pound;
ii. Wine costs $10/bottle, cheese costs $10/pound;
iii. Wine costs $20/bottle, cheese costs $10/pound;
iv. Wine costs $20/bottle, cheese costs $10/pound
b. Describe why budget constraints ii and iii will probably provide less utility than does budget constraint i. Are there any situations where this would not be the case?
i. Wine costs $10/bottle, cheese costs $5/pound;
ii. Wine costs $10/bottle, cheese costs $10/pound;
iii. Wine costs $20/bottle, cheese costs $10/pound;
iv. Wine costs $20/bottle, cheese costs $10/pound
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Describe why budget constraint iv provides precisely the same options to Oscar as does budget constraint
i. What income (in euros, €) would Oscar need if he is to afford these same options if wine costs €15 per bottle and cheese costs €7:50 per pound?
How about a situation in England where wine costs £4 per bottle and cheese costs £2 per pound?
What general conclusions can you draw by comparing all the budget constraints mentioned in this part?
i. What income (in euros, €) would Oscar need if he is to afford these same options if wine costs €15 per bottle and cheese costs €7:50 per pound?
How about a situation in England where wine costs £4 per bottle and cheese costs £2 per pound?
What general conclusions can you draw by comparing all the budget constraints mentioned in this part?
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While standing in line to buy popcorn at your favorite theater, you hear someone behind you say, "This popcorn isn't worth its price—I'm not buying any." How would you graph this person's situation?
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A careful reader of this book will have read footnotes 2 and 5 in this chapter.
Explain why these can be summarized by the commonsense idea that a person is maximizing his or her utility only if getting an extra dollar to spend would provide the same amount of extra utility no matter which good he or she chooses to spend it on. (Hint: Suppose this condition were not true—is utility as large as possible?)
Explain why these can be summarized by the commonsense idea that a person is maximizing his or her utility only if getting an extra dollar to spend would provide the same amount of extra utility no matter which good he or she chooses to spend it on. (Hint: Suppose this condition were not true—is utility as large as possible?)
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Most states require that you purchase automobile insurance when you buy a car.
Use an indifference curve diagram to show that this mandate reduces utility for some people.
1. What kinds of people are most likely to have their utility reduced by such a law?
2. Why do you think that the government requires such insurance?
Use an indifference curve diagram to show that this mandate reduces utility for some people.
1. What kinds of people are most likely to have their utility reduced by such a law?
2. Why do you think that the government requires such insurance?
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As we showed in this chapter, utility maximization requires that a person equate the marginal rate of substitution (MRS) to the ratio of the goods' prices PX/PY. When asked to explain the reasoning behind this condition, students gave the following answers:
Which of these students is stating the result correctly? What errors are the other two making?
Student A: Because the MRS shows the ratio of good Y to good X that this person wishes to consume, he or she must equate this ratio to the price ratio because the price ratio shows how much Y he or she can buy if one less X is bought.
Student B: Because the MRS shows how this person is willing to trade good X for good Y he should choose prices that also reflect this ratio.
Student C: Because the MRS shows how this person is willing to trade good X for good Y, he or she must adjust purchases so that this ratio is equal to the ratio of the goods' prices.
Which of these students is stating the result correctly? What errors are the other two making?
Student A: Because the MRS shows the ratio of good Y to good X that this person wishes to consume, he or she must equate this ratio to the price ratio because the price ratio shows how much Y he or she can buy if one less X is bought.
Student B: Because the MRS shows how this person is willing to trade good X for good Y he should choose prices that also reflect this ratio.
Student C: Because the MRS shows how this person is willing to trade good X for good Y, he or she must adjust purchases so that this ratio is equal to the ratio of the goods' prices.
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Suppose that an electric company charges consumers $:10 per kilowatt hour for electricity for the first 1,000 kilowatt hours used in a month but $:15 for each extra kilowatt hour after that.
Draw the budget constraint for a consumer facing this price schedule, and discuss why many individuals may choose to consume exactly 1,000 kilowatt hours.
Draw the budget constraint for a consumer facing this price schedule, and discuss why many individuals may choose to consume exactly 1,000 kilowatt hours.
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Suppose an individual consumes three items: steak, lettuce, and tomatoes. If we were interested only in examining this person's steak purchases, we might group lettuce and tomatoes into a single composite good called "salad." Suppose also that this person always makes salad by combining two units of lettuce with one unit of tomato.
a. How would you define a unit of salad to show (along with steak) on a two-good graph?
a. How would you define a unit of salad to show (along with steak) on a two-good graph?
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Suppose an individual consumes three items: steak, lettuce, and tomatoes. If we were interested only in examining this person's steak purchases, we might group lettuce and tomatoes into a single composite good called "salad." Suppose also that this person always makes salad by combining two units of lettuce with one unit of tomato.
b. How does the price of salad (PS) relate to the price of lettuce (PL) and the price of tomatoes (PT)?
b. How does the price of salad (PS) relate to the price of lettuce (PL) and the price of tomatoes (PT)?
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Suppose an individual consumes three items: steak, lettuce, and tomatoes. If we were interested only in examining this person's steak purchases, we might group lettuce and tomatoes into a single composite good called "salad." Suppose also that this person always makes salad by combining two units of lettuce with one unit of tomato.
c. What is this person's budget constraint for steak and salad?
c. What is this person's budget constraint for steak and salad?
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Suppose an individual consumes three items: steak, lettuce, and tomatoes. If we were interested only in examining this person's steak purchases, we might group lettuce and tomatoes into a single composite good called "salad." Suppose also that this person always makes salad by combining two units of lettuce with one unit of tomato.
d. Would a doubling of the price of steak, the price of lettuce, the price of tomatoes, and this person's income shift the budget constraint described in part c?
d. Would a doubling of the price of steak, the price of lettuce, the price of tomatoes, and this person's income shift the budget constraint described in part c?
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Suppose an individual consumes three items: steak, lettuce, and tomatoes. If we were interested only in examining this person's steak purchases, we might group lettuce and tomatoes into a single composite good called "salad." Suppose also that this person always makes salad by combining two units of lettuce with one unit of tomato.
Suppose instead that the way in which this person made salad depended on the relative prices of lettuce and tomatoes. Now could you express this person's choice problem as involving only two goods? Explain.
Suppose instead that the way in which this person made salad depended on the relative prices of lettuce and tomatoes. Now could you express this person's choice problem as involving only two goods? Explain.
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Suppose a person has $8:00 to spend only on apples and bananas. Apples cost $:40 each, and bananas cost $:10 each.
a. If this person buys only apples, how many can be bought?
a. If this person buys only apples, how many can be bought?
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Suppose a person has $8:00 to spend only on apples and bananas. Apples cost $:40 each, and bananas cost $:10 each.
b. If this person buys only bananas, how many can be bought?
b. If this person buys only bananas, how many can be bought?
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Suppose a person has $8:00 to spend only on apples and bananas. Apples cost $:40 each, and bananas cost $:10 each.
c. If the person were to buy 10 apples, how many bananas could be bought with the funds left over?
c. If the person were to buy 10 apples, how many bananas could be bought with the funds left over?
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Suppose a person has $8:00 to spend only on apples and bananas. Apples cost $:40 each, and bananas cost $:10 each.
d. If the person consumes one less apple (that is, nine), how many more bananas could be bought? Is this rate of trade-off the same no matter how many apples are relinquished?
d. If the person consumes one less apple (that is, nine), how many more bananas could be bought? Is this rate of trade-off the same no matter how many apples are relinquished?
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Suppose a person has $8:00 to spend only on apples and bananas. Apples cost $:40 each, and bananas cost $:10 each.
e. Write down the algebraic equation for this person's budget constraint, and graph it showing the points mentioned in parts a through d (using graph paper might improve the accuracy of your work).
e. Write down the algebraic equation for this person's budget constraint, and graph it showing the points mentioned in parts a through d (using graph paper might improve the accuracy of your work).
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Ms. Caffeine enjoys coffee (C) and tea (T) according to the function U(C, T) = 3C + 4T.
What does her utility function say about her MRS of coffee for tea? What do her indifference curves look like?
What does her utility function say about her MRS of coffee for tea? What do her indifference curves look like?
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Ms. Caffeine enjoys coffee (C) and tea (T) according to the function U(C, T) = 3C + 4T.
If coffee and tea cost $3 each and Ms. Caffeine has $12 to spend on these products, how much coffee and tea should she buy to maximize her utility?
If coffee and tea cost $3 each and Ms. Caffeine has $12 to spend on these products, how much coffee and tea should she buy to maximize her utility?
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Ms. Caffeine enjoys coffee (C) and tea (T) according to the function U(C, T) = 3C + 4T.
Draw the graph of her indifference curve map and her budget constraint, and show that the utility maximizing point occurs only on the T-axis where no coffee is bought.
Draw the graph of her indifference curve map and her budget constraint, and show that the utility maximizing point occurs only on the T-axis where no coffee is bought.
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Ms. Caffeine enjoys coffee (C) and tea (T) according to the function U(C, T) = 3C + 4T.
Would this person buy any coffee if she had more money to spend?
Would this person buy any coffee if she had more money to spend?
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Ms. Caffeine enjoys coffee (C) and tea (T) according to the function U(C, T) = 3C + 4T.
How would her consumption change if the price of coffee fell to $2?
How would her consumption change if the price of coffee fell to $2?
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Vera is an impoverished graduate student, who has only $100 a month to spend on food. She has read in a government publication that she can assure an adequate diet by eating only peanut butter and carrots in the fixed ratio of 2 pounds of peanut butter to 1 pound of carrots, so she decides to limit her diet to that regime.
a. If peanut butter costs $4 per pound and carrots cost $2 per pound, how much can she eat during the month?
b. Suppose peanut butter costs rise to $5 because of peanut subsidies introduced by a politically corrupt government. By how much will Vera have to reduce her food purchases?
c. How much in food aid would the government have to give Vera to compensate for the effects of the peanut subsidy?
d. Explain why Vera's preferences are of a very special type here. How would you graph them?
a. If peanut butter costs $4 per pound and carrots cost $2 per pound, how much can she eat during the month?
b. Suppose peanut butter costs rise to $5 because of peanut subsidies introduced by a politically corrupt government. By how much will Vera have to reduce her food purchases?
c. How much in food aid would the government have to give Vera to compensate for the effects of the peanut subsidy?
d. Explain why Vera's preferences are of a very special type here. How would you graph them?
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Assume consumers are choosing between housing services (H) measured in square feet and consumption of all other goods (C) measured in dollars.
a. Show the equilibrium position in a diagram.
b. Now suppose the government agrees to subsidize consumers by paying 50 percent of their housing cost. How will their budget line change? Show the new equilibrium.
c. Show in a diagram the minimum amount of income supplement the government would have to give individuals instead of a housing subsidy to make them as well-off as they were in part b.
d. Describe why the amount shown in part c is smaller than the amount paid in subsidy in part b.
a. Show the equilibrium position in a diagram.
b. Now suppose the government agrees to subsidize consumers by paying 50 percent of their housing cost. How will their budget line change? Show the new equilibrium.
c. Show in a diagram the minimum amount of income supplement the government would have to give individuals instead of a housing subsidy to make them as well-off as they were in part b.
d. Describe why the amount shown in part c is smaller than the amount paid in subsidy in part b.
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Suppose a person consumes only two goods, food (F)
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
a. Explain why the budget constraint for this person
can be written in this way and graph the constraint.
Also show this person's utility-maximizing choices
for F and X.
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
a. Explain why the budget constraint for this person
can be written in this way and graph the constraint.
Also show this person's utility-maximizing choices
for F and X.
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Suppose a person consumes only two goods, food (F)
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
b.Suppose that the government provides a food subsidy to this person that allows him or her to consume all the food desired at half price. How would
that shift this person's budget constraint?How
would it affect food and non-food purchases?
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
b.Suppose that the government provides a food subsidy to this person that allows him or her to consume all the food desired at half price. How would
that shift this person's budget constraint?How
would it affect food and non-food purchases?
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Suppose a person consumes only two goods, food (F)
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
c.Suppose now that the government requires that in
order to buy food at half price this person must pay
C dollars for a food credit card. Show graphically
the maximum amount C could be in order to get
this person to buy the card.
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
c.Suppose now that the government requires that in
order to buy food at half price this person must pay
C dollars for a food credit card. Show graphically
the maximum amount C could be in order to get
this person to buy the card.
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Suppose a person consumes only two goods, food (F)
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
d. With C set at the amount described in the previous part, will this person consume more or less food than he or she did initially in part a?
and other goods (X). This person's budget constraint
can be written as
PF+X=I
where P is the relative price of food and X and I are
measured in terms of prices of non-food items (that is,
say inflation-adjusted dollars).
d. With C set at the amount described in the previous part, will this person consume more or less food than he or she did initially in part a?
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Suppose that people derive utility from two goods—
housing (H) and all other consumption goods (C).
a. Show a typical consumer's allocation of his or her
income between H and C.
b. Suppose that the government decides that the level
of the housing shown in part a (say, H) is "substandard" and requires that all people buy H > H
instead. Show that this law would reduce this
person's utility.
c. One way to return this person to the initial level of utility would be to give him or her extra income. On your graph, show how much extra income this would require.
d. Another way to return this person to his or her initial level of utility would be to provide a housing subsidy that reduces the price of housing. On your graph, show this solution as well.
housing (H) and all other consumption goods (C).
a. Show a typical consumer's allocation of his or her
income between H and C.
b. Suppose that the government decides that the level
of the housing shown in part a (say, H) is "substandard" and requires that all people buy H > H
instead. Show that this law would reduce this
person's utility.
c. One way to return this person to the initial level of utility would be to give him or her extra income. On your graph, show how much extra income this would require.
d. Another way to return this person to his or her initial level of utility would be to provide a housing subsidy that reduces the price of housing. On your graph, show this solution as well.
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Demand function
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A representation of how quantity demanded depends on prices, income, and preferences.
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Homogeneous demand function
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Quantity demanded does not change when prices and income increase in the same proportion.
Only if inflation increases some incomes faster or slower than price changes does it have an effect on budget constraints, on the quantities of goods demanded, and on people's well-being
Only if inflation increases some incomes faster or slower than price changes does it have an effect on budget constraints, on the quantities of goods demanded, and on people's well-being
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Normal good
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A good that is bought in greater quantities as income increases.
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Inferior good
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A good that is bought in smaller quantities as income increases.
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Why most gasoline stations along a particular stretch of road charge about the same price;
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Why the entry of big-box retailers like Target or Walmart into a market causes prices at small local retailers to fall.
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Giffen's paradox
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A situation in which an increase in a good's price leads people to consume more of the good.
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Changes in the price of another good create both income and substitution effects in a person's demand for, say, coffee. Describe those effects in the following situations and state whether they work in the same direction or in opposite directions in their impact on coffee purchases.
1. A decrease in the price of tea
2. A decrease in the price of cream
1. A decrease in the price of tea
2. A decrease in the price of cream
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Complements
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Two goods such that when the price of one increases, the quantity demanded of the other falls.
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Substitutes
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Two goods such that if the price of one increases, the quantity demanded of the other rises.
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Increase or decrease in quantity demanded
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The increase or decrease in quantity demanded caused by a change in the good's price. Graphically represented by the movement along a demand curve.
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Increase or decrease in demand
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The change in demand for a good caused by changes in the price of another good, in income, or in preferences. Graphically represented by a shift of the entire demand curve.
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Consumer Surplus
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The extra value individuals receive from consuming a good over what they pay for it. What people would be willing to pay for the right to consume a good at its current price.
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A shift outward in a demand curve can be described either by the extent of its shift in the horizontal direction or by its shift in the vertical direction. How would the following shifts be shown graphically?
1. News that nutmeg cures the common cold causes people to demand 2 million pounds more nutmeg at each price.
2. News that nutmeg cures the common cold causes people to be willing to pay $1 more per pound of nutmeg for each total quantity demanded.
1. News that nutmeg cures the common cold causes people to demand 2 million pounds more nutmeg at each price.
2. News that nutmeg cures the common cold causes people to be willing to pay $1 more per pound of nutmeg for each total quantity demanded.
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Price elasticity of demand
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The percentage change in the quantity demanded of a good in response to a 1 percent change in its price while holding other determinants of demand constant.
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Elasticity
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The measure of the percentage change in one variable brought about by a 1 percent change in some other variable
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P elasticity of demand =
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the % change in quantity demanded/the % change in price
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When there are only two goods, the assumption of a diminishing MRS requires that substitution effects have price and quantity move in opposite directions for any good. Explain why this is so. Do you think the result holds when there are more than two goods?
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George has rather special preferences for streaming TV shows. As his income rises, he will increase his streaming until he reaches a total of seven shows per week. After he is streaming seven shows per week, however, further increases in his income will not cause him to stream more than seven shows (because he has no more time for watching)
a. Provide a simple sketch of George's indifference curve map.
b. Explain how George will respond to a fall in the price of streamed TV shows
a. Provide a simple sketch of George's indifference curve map.
b. Explain how George will respond to a fall in the price of streamed TV shows
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Explain whether the following events would result in a move along an individual's demand curve for popcorn or in a shift of the curve. If the curve would shift, in what direction?
a. An increase in the individual's income
b. A decline in popcorn prices
c. An increase in prices for pretzels
d. A reduction in the amount of butter included in a box of popcorn e. The presence of long waiting lines to buy popcorn
f. A sales tax on all popcorn purchases
a. An increase in the individual's income
b. A decline in popcorn prices
c. An increase in prices for pretzels
d. A reduction in the amount of butter included in a box of popcorn e. The presence of long waiting lines to buy popcorn
f. A sales tax on all popcorn purchases
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Is the following statement true or false?
Explain. "Every Giffen good must be inferior, but not every inferior good exhibits the Giffen paradox."
Explain. "Every Giffen good must be inferior, but not every inferior good exhibits the Giffen paradox."
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Elizabeth M. Suburbs makes $200 a week at her summer job and spends her entire weekly income on new running shoes and designer jeans, because these are the only two items that provide utility to her. Furthermore, Elizabeth insists that for every pair of jeans she buys, she must also buy a pair of shoes (without the shoes, the new jeans are worthless). Therefore, she buys the same number of pairs of shoes and jeans in any given week
a. If jeans cost $20 and shoes cost $20, how many will Elizabeth buy of each?
b. Suppose that the price of jeans rises to $30 a pair. How many shoes and jeans will she buy?
c. Show your results by graphing the budget constraints from parts a and b. Also draw Elizabeth's indifference curves.
d. To what effect (income or substitution) do you attribute the change in utility levels between parts a and b?
e. Now we look at Elizabeth's demand curve for jeans. First, calculate how many pairs of jeans she will choose to buy if jeans prices are $30, $20, $10, or $5.
f. Use the information from part e to graph Ms. Suburbs's demand curve for jeans.
g. Suppose that her income rises to $300. Graph her demand curve for jeans in this new situation.
a. If jeans cost $20 and shoes cost $20, how many will Elizabeth buy of each?
b. Suppose that the price of jeans rises to $30 a pair. How many shoes and jeans will she buy?
c. Show your results by graphing the budget constraints from parts a and b. Also draw Elizabeth's indifference curves.
d. To what effect (income or substitution) do you attribute the change in utility levels between parts a and b?
e. Now we look at Elizabeth's demand curve for jeans. First, calculate how many pairs of jeans she will choose to buy if jeans prices are $30, $20, $10, or $5.
f. Use the information from part e to graph Ms. Suburbs's demand curve for jeans.
g. Suppose that her income rises to $300. Graph her demand curve for jeans in this new situation.
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Currently, Paula is maximizing utility by purchasing five TV dinners (T) and four Lean Cuisine meals (L) each week.
a. Graph Paula's initial utility-maximizing choice.
b. Suppose that the price of T rises by $1 and the price of L falls by $1:25. Can Paula still afford to buy her initial consumption choices? What do you know about her new budget constraint?
c. Use your graph to show why Paula will choose to consume more L and less T given her new budget constraint. How do you know that her utility will increase?
d. Some economists define the "substitution effect" of a price change to be the kind of change shown in part c. That is, the effect represents the change in consumption when the budget constraint rotates about the initial consumption bundle. Precisely how does this notion of a substitution effect differ from the one defined in the text?
e. If the substitution effect were defined as in part d, how would you define "the income effect" in order to get a complete analysis of how a person responds to a price change?
a. Graph Paula's initial utility-maximizing choice.
b. Suppose that the price of T rises by $1 and the price of L falls by $1:25. Can Paula still afford to buy her initial consumption choices? What do you know about her new budget constraint?
c. Use your graph to show why Paula will choose to consume more L and less T given her new budget constraint. How do you know that her utility will increase?
d. Some economists define the "substitution effect" of a price change to be the kind of change shown in part c. That is, the effect represents the change in consumption when the budget constraint rotates about the initial consumption bundle. Precisely how does this notion of a substitution effect differ from the one defined in the text?
e. If the substitution effect were defined as in part d, how would you define "the income effect" in order to get a complete analysis of how a person responds to a price change?
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Firm
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Any organization that turns inputs into outputs.
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Production function
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The mathematical relationship between inputs and outputs.
q = f(k,l,M)
q = f(k,l,M)
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Suppose that corns are produced according to the production function q = 100K + 50L, where q represents pounds of corns produced per hour, K is the number of acres of land devoted to corn production, and L represents the number of workers hired each hour.
1. Does this production function exhibit increasing, constant, or decreasing returns to scale?
2. Give one reason why this production function is probably not a very reasonable one.
1. Does this production function exhibit increasing, constant, or decreasing returns to scale?
2. Give one reason why this production function is probably not a very reasonable one.
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Why are allocations on the production possibility frontier technically efficient?
What is technically inefficient about allocations inside the frontier?
Do inefficient allocations necessarily involve any unemployment of factors of production?
What is technically inefficient about allocations inside the frontier?
Do inefficient allocations necessarily involve any unemployment of factors of production?
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Gasoline is sold through local gasoline stations under perfectly competitive conditions. All gasoline station owners face the same long-run average cost curve given by
AC = .01q - 1 + 100/q
and the same long-run marginal cost curve given by
MC = 02q - 1 where q is the number of gallons sold per day.
a. Assuming the market is in long-run equilibrium, how much gasoline will each individual owner sell per day? What are the long-run average and marginal cost at this output level?
AC = .01q - 1 + 100/q
and the same long-run marginal cost curve given by
MC = 02q - 1 where q is the number of gallons sold per day.
a. Assuming the market is in long-run equilibrium, how much gasoline will each individual owner sell per day? What are the long-run average and marginal cost at this output level?
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question
Gasoline is sold through local gasoline stations under perfectly competitive conditions. All gasoline station owners face the same long-run average cost curve given by
AC = .01q - 1 + 100/q
and the same long-run marginal cost curve given by
MC = 02q - 1 where q is the number of gallons sold per day.
b. The market demand for gasoline is given by
QD = 2,500,000 - 500,000P where QD is the number of gallons demanded per day and P is the price per gallon.
Given your answer to part a, what will be the price of gasoline in long-run equilibrium?
How much gasoline will be demanded, and how many gas stations will there be?
AC = .01q - 1 + 100/q
and the same long-run marginal cost curve given by
MC = 02q - 1 where q is the number of gallons sold per day.
b. The market demand for gasoline is given by
QD = 2,500,000 - 500,000P where QD is the number of gallons demanded per day and P is the price per gallon.
Given your answer to part a, what will be the price of gasoline in long-run equilibrium?
How much gasoline will be demanded, and how many gas stations will there be?
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question
Gasoline is sold through local gasoline stations under perfectly competitive conditions. All gasoline station owners face the same long-run average cost curve given by
AC = .01q - 1 + 100/q
and the same long-run marginal cost curve given by
MC = 02q - 1 where q is the number of gallons sold per day.
c. Suppose that because of the development of solarpowered cars, the market demand for gasoline shifts inward to
QD = 2,000,000 - 1,000,000P
In long-run equilibrium, what will be the price of gasoline? How much total gasoline will be demanded, and how many gas stations will there be?
AC = .01q - 1 + 100/q
and the same long-run marginal cost curve given by
MC = 02q - 1 where q is the number of gallons sold per day.
c. Suppose that because of the development of solarpowered cars, the market demand for gasoline shifts inward to
QD = 2,000,000 - 1,000,000P
In long-run equilibrium, what will be the price of gasoline? How much total gasoline will be demanded, and how many gas stations will there be?
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Suppose the production possibility frontier for cheeseburgers (C) and milkshakes (M)
is given by C + 2M = 600
a. Graph this frontier.
b. Assuming that people prefer to eat two cheeseburgers with every milkshake, how much of each product will be produced? Indicate this point on your graph.
is given by C + 2M = 600
a. Graph this frontier.
b. Assuming that people prefer to eat two cheeseburgers with every milkshake, how much of each product will be produced? Indicate this point on your graph.
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A fledgling microeconomics student is having some trouble grasping the concept of short-run producer surplus. In exasperation, he blurts out, "This is absolute balderdash. I can understand that producer surplus is a good thing for firms because it measures the improvement in their welfare relative to a situation where they cannot participate in the market. But then I'm told that fixed costs are a component of short-run producer surplus. Aren't fixed costs a bad thing? They must be paid! How can they be one component of a good thing?" Can you set this student straight? (Hint: When is short-run producer surplus zero?)
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Cost curves shift to a new position when?
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the prices of inputs change. Improvements in production techniques also shift cost curves because the same level of output can then be produced with fewer inputs. Expanding one output in a multiproduct firm may reduce costs of some other output when there are economies of scope.
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The two most important unit-cost concepts are
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average cost (that is, cost per unit of output) and marginal cost (that is, the incremental cost of the last unit produced). Average and marginal cost curves can be constructed directly from the total cost curve. The shape of these curves depends on the nature of the firm's production function.
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Explain why the assumption of cost minimization implies that the total cost curve must have a positive slope: An increase in output must always increase total cost.
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