1. Paintball versus Virtual Reality Sessions. Jackson has a fixed budget for entertainment and has tentatively decided to get eight paintball sessions and five virtual-reality (VR) sessions. The price of a VR session is $32 and the price of a paintball session is $8. After some prompting from a friend, Jackson said, to get an additional VR session, I would be willing to sacrifice two paintball sessions.

a. Does Jackson s tentative choice maximize his utility subject to his entertainment budget?

b. If not, should he get more paintball sessions or more VR sessions?

c. Illustrate the situation with a graph, with VR on the horizontal axis and paintball on the vertical axis.

2. Horsepower versus Cubic Feet. Carla has a fixed budget for a new car and has tentatively decided to buy a car with 80 horsepower (hp) and 100 cubic feet (cf) of interior space. Given the current selection of cars and their prices, the price of horsepower is one third the price of cubic feet. After some prompting from a salesperson, Carla said, to get an additional unit of horsepower I would be willing to sacrifice 2 cubic feet of interior space.

a. Does her tentative choice (80 hp and 100 cf) maximize her utility subject to her auto budget? b. If not, should she choose an auto with more horsepower or less horsepower?

c. Illustrate the situation with a graph, with horsepower on the horizontal axis and cubic feet on the vertical axis.

3. Ask the Consumer. Recall the application what s Your MRS? Which explored how to spend a firm’s party budget on punch and cookies? Suppose the price of punch is $4 and the price of cookies is $1. When you ask the typical employee about her marginal rate of substitution, her answer is three cookies per cup of punch.

a. Should your firm spend more on cookies or more on punch?

b. Illustrate your answer with a complete consumer choice graph, with punch on the horizontal axis and cookies on the vertical axis.

4. MPG versus Mozart Speed. Wolfgang has a fixed budget for a new car and has tentatively decided to buy a car that gets 20 miles per gallon (mpg) and has a performance level of 60 ms (the maximum speed at which a turntable can play Mozart s first symphony without skipping). A salesperson recently asked Wolfgang about his attitudes toward cars with different combinations of mpg and ms. Wolfgang would prefer a car with 19 mpg and 64 ms to his tentative choice, but would prefer his tentative choice to a car with 19 mpg and 62 ms. Suppose that the cost of an additional mpg is six times the cost of an additional unit of ms.

a. Does Wolfgang s tentative choice (20 mpg and 60 ms) maximize his utility, subject to his auto budget? If not, should he choose an auto with more or fewer mpg?

b. Illustrate your answer with a completely labeled graph. Label Wolfgang s tentative choice with a T and his utility-maximizing choice with a U.

5. Bundling TV Channels. Your monthly budget for entertainment is $48, and your entertainment goods are cable TV and arcade games. Arcade games are $1 each.

a. Suppose the cable company has a price of $4 per channel. Draw your budget line.

b. The following table shows the marginal rate of substitution for different combinations of channels and games. Find the utility-maximizing combination and show it on your graph with an indifference curve.

c. Suppose the cable company switches from per channel pricing to a bundle plan: You get six stations for a cost of $24 per month, but zero stations if you don t pay the full $24. In other words, the company tells you to take it (six stations) or leave it (zero stations). Identify the new budget points on your graph. Does the switch make you better or worse off?

d. Suppose that you decide to take the bundled offer. On your graph, show that taking it is better than leaving it (picking zero channels).

6. Higher Prices versus Lower Income. Recall the example of Maxine, who in January has an income of $30 and pays $3 per movie and $1 per book.
a. In February, the prices of movies and books double, but her income stays at $30. Draw her February budget line and shade her budget set.
b. In March, her income is cut in half to $15, but the price of books returns to $1 and the price of movies returns to $3. Draw her March budget line and shade her budget set.
c. Going from February to March, does her utility level increase, decrease, or stay the same? Explain.
7. Is the Average Bundle Better? Biff consumes two entertainment goods, arcade games and CDs. When you ask him in week one, How many arcade games are you willing to sacrifice for one more CD? He says, two. When you ask him the same question a week later (week two), he says, five. Over this period, his underlying preferences for arcade games and CDs haven t changed.
a. What could explain the change in his trade-off from week one to week two? Illustrate with a completely labeled graph, with CDs on the horizontal axis and arcade games on the vertical axis.
b. Suppose Biff reached the same utility levels in weeks one and two. In week three, you offer to provide biff his average consumption bundle from weeks one and two that is, the average number of CDs and the average number of arcade games. Will he be better off, worse off, or equally well off compared to weeks one and two? Illustrate with a completely labeled graph.
8. Free Goods and the Marginal Principle. Consider the Amazon.com experiences with cheap shipping for orders exceeding $25. Suppose the typical consumer buys $15 books, and the regular shipping charge is $4, regardless of how many books are purchased.
a. In the United States the free-shipping offer changes the marginal cost of a second book from $ _____ to $ _____. In France, the initial cheap-shipping offer changes the marginal cost of a second book from $ _____ to $ _____.
b. Consider a U.S. consumer who buys a single book when there is a $4 shipping charge, and responds to the offer of free shipping by purchasing two books rather than only one. The consumer s marginal benefit for the first book is greater than _____, and the marginal benefit for the second book is between _____ and _____.

Transcribed Image Text:

Quantity Channels | GamesMarginal Rate of Substitution $44 40 36 32 28 24 4 4