CHAPTER 6
CONSUMER CHOICE
Even Number ANSWERS, SOLUTIONS, AND EXERCISES
ANSWERS TO ONLINE REVIEW QUESTIONS
2. A change in income will shift the budget line in a parallel fashion—increases in income shift the
budget line outward and away from the origin, decreases shift it inward and nearer the origin.
Changes in income alone do not affect the budget line’s slope.
A change in one or both prices will rotate the budget line and change its slope. For example, a
decrease in the price of the good measured on the horizontal axis will cause a rotation of the budget
line around its vertical axis intercept; the rotation will result in a horizontal intercept farther to the
right.
4. [Using the Marginal Utility Approach] The law of diminishing marginal utility states that marginal
utility declines as more of a good is consumed. It is a reasonable assumption for most goods: The
more of a good one consumes, the less additional satisfaction is derived from each additional unit.
There are, indeed, exceptions to the law. One example might be found among collectors. As the
collection becomes more complete, the marginal utility of additional paintings might actually
increase.
Marginal utility would be negative for any good that a consumer dislikes. An additional unit
consumed in this case would decrease utility. One example is garbage.
6. The statement makes an error. Rationality does not mean that individuals make choices that are
“sensible” to others. Preferences are called rational if (1) they satisfy the logical consistency
requirement detailed in question 5, and if (2) the consumer can compare any two combinations of
goods and state either that he/she is indifferent between them or that he/she prefers one of them.
8. A change in the price of one good relative to another gives rise to the substitution effect—the
tendency of consumers to substitute more of the good made relatively cheaper by the price decline
for the good that is now relatively more expensive. Hence, the substitution effect always works to
increase the quantity demanded of a good whose price has decreased. In this sense, the substitution
effect is always consistent with the law of demand.
The income effect is the change in quantity demanded that arises because of the change in
purchasing power caused by a price change. For example, if the price of a good declines, a given
income will “go farther”—as if the consumer has more income.
Any given price change sets in motion both income and substitution effects. If a good is normal,
these effects reinforce each other to increase quantity demanded, in the case of a price decrease,
or decrease quantity demanded when price increases. When a good is inferior, the income and
substitution effects work in opposite directions. The question then becomes, which effect is
stronger? If the substitution effect dominates, the law of demand will still hold; but if the income
effect is stronger, a price increase will actually cause quantity demanded to increase, in violation of
the law of demand.
10. The market demand curve for a particular good is found as the horizontal sum of the demand
curves of all consumers in the market for the good. Each individual demand is found by varying the
price of the good and observing how the optimal quantity of a good changes as the consumer’s
budget line rotates outward or inward.
PROBLEM SET
2. [Indifference Curve Approach]
a.
The
original equilibrium is at point A.
b. A new tangency will occur at a point where she consumes more clothes and less
food, such as point B.
c. A new tangency will occur at a point where she consumes fewer clothes and more food, such as
point C.
4. [Marginal Utility Approach] No, he is not maximizing utility. The marginal utility Parvez gets per
dollar spent on his last novel is 5, whereas the marginal utility Parvez gets per dollar spent on his last
CD is 4. He should spend less of his budget on CDs and more on novels. As he does so, the marginal
utility of CDs will rise and the marginal utility of novels will fall, until the ratio of marginal utility to
price is the same for both goods.
6. [Indifference Curve Approach]
a.
The original equilibrium is at point A.
b. The new budget line is BL2. The new tangency must occur at a point where Rafaella is consuming
MORE THAN 4 pounds of chicken, and LESS than 10 eggs, for instance, at point B.
8. [Indifference Curve Approach]
a.
The original equilibrium is at point A.
b. The new budget line is BL2. The new tangency must occur at a point with MORE THAN 25
pounds of potatoes, for instance, at point B. If potatoes are inferior, then Cameron will consume
more potatoes and fewer steaks than at his original position.
10. [Marginal Utility Approach]
Concerts at $20 each
Movies at $10 each
Max’s utility maximizing combination is at the point where MUC/PC = MUM/PM. This is achieved
with 1 concert and 18 movies per month. With these new marginal values, concerts are an inferior
good.
12. [Marginal Utility Approach]
Budget = $200
Concerts at $20 each
Movies at $10 each
Max’s utility maximizing combination is at the point where MU C/PC = MUM/PM. This is achieved at 9 concerts and 2
movies. With these new marginal values, movies are an inferior good.
14.
a.
b.
c.
MORE CHALLENGING
16. Nothing would happen to consumer choices in this situation. If prices alone were increasing, then
the budget line would shift towards the origin. However, in this example, wages are increasing by
enough to keep the combination of goods and services the consumer can afford unchanged.
18. a. Current consumption is at A, where 2,500 units of food and 5,000 units of shelter are
consumed. The Smiths spend $5000 = $2 x 2500 on food and $5000 = $1 x 5000 on shelter.
b. When the price of housing rises to $2 per square foot, the new budget line is given by the line
marked B′ in the figure above. The Smiths cannot continue to consume at point A.
c. The income supplement shifts the budget constraint rightward to the line marked B′′. The original
consumption level, represented by point A, is again affordable.
d. No, the family will not necessarily return to point A. The utility-maximizing consumption choice
will be somewhere on the new budget line, B′′. But all the points on this budget line below A could
have been reached with the original prices and income, and were not chosen before, so they must be
less preferred than point A. They will not be chosen now. All the points above point A are newly
available. Any of these points might be preferred to point A, and could be chosen. (If you use the
indifference curve approach, you can actually show that point A will never be chosen after the cash
grant. To do so, draw an indifference curve tangent to point A, reflecting the best initial choice
before the price change and the cash grant. Then, after the price change and the cash grant, the best
choice is the point of tangency between some new indifference curve and budget line B”. This new
tangency cannot occur at point A, as you can see by trying to draw it.)