Answer all questions in detail

PRACTICE EXERCISE - UTILITY # 1 I, A student asserts in class that the income and substitution effects lead to a decrease in the consumption of a normal good when the price decreases. Do you agree with the statement? Explain using an example. 2. Assume that a person only purchases two goods, food and clothing, and has a fixed budget constraint. Both goods are normal goods. If the price of food decreases, what will happen to the consumption of food and clothing based on the income effect? 3. A consumer finds only three products, X, Y, and Z, are for sale. The amount of utility which their consumption will yield are as shown in the table below. Assume that the prices of X, Y, and Z are $10, $2, and $8, respectively, and that the consumer has an income of $74 to spend. a. Complete the following table by computing the marginal utility per dollar for succes- sive units of X, Y, and Z to one or two decimal places. b. How many units of X, Y, and Z will the consumer buy when maximizing utility? Show this result using the utility maximization formula. C. Why would the consumer not be maximizing utility by purchasing 2 units of X, 4 units of Y, and 1 unit of Z? Product X Product Y Product Z Marginal Marginal Marginal utility utility utility Quantity Utility per $ Quantity Utility per $ Quantity Utility per $ 42 14 32 82 2 26 2 60 3 118 3 36 3 84 4 148 4 44 4 100 5' 170 5 50 5 110 6 182 6 54 6 116 182 56.4 120 4 . A consumer has an income of $24 to spend each day. The only two goods the consumer is interested in purchasing are goods A and B. The marginal-utility schedules for these two goods are shown in the table below. The price of B does not change and is $2. The marginal utility per dollar from B is also shown in the table. But the price of A varies as shown in the table. The marginal utility per dollar from A when the price of A is $8, $4, and $2 is shown in the table. Good A Good B Quantity MU MU/$8 MU/$4 MU/$2 MU MU/$2 48 6 12 24 24 12 32 16 15 8 24 12 12 6 auAWN 16 NNA DO 8 8 4 8 in Complete the table below to show how much of A the consumer will buy each week at each of the three possible prices of A. Also, show how much B will be demanded when the price of A changes Quantity of A Quantity of B Price of A demanded Price of B demanded $8.00 $2.00 A. M . HOROWITZ 4.00 2.00 2.00 2.00CONSUMER CHOICE HOMEWORK # 2 1.7 You have six hours to study for two exams tomorrow. The following table shows the relationship between hours of 2.10 In early 2015, gasoline prices in many parts of the United study and test scores: States had fallen to below $2.00 per gallon, which a news story called "one of the swiftest declines on record." Is Economics Psychology gasoline likely to be an inferior good or a normal good for Hours Score Hours Score most people? Is your answer important for predicting how much the quantity of gasoline demanded will increase as a 54 O 54 result of the price decline? Briefly explain. 62 60 Source: Nick Timiraos, "As Gasoline Heads Toward $2, the Benefits 2 69 2 65 Start to Trickle Down," Wall Street Journal, January 22, 2015. 3 75 3 69 2.11 According to the U.S. Energy Information Administra- 4. 80 4 72 ion, the average price of heating oil fell to under $3.00 a 5 74 gallon during the winter of 2014-2015, the lowest price in 84 more than four years. About 6.2 million U.S. households 87 75 in the Northeast rely on the fuel to heat their homes. For the following questions, assume that no factor that affects a. Use the rule for determining optimal purchases to de- the demand for heating oil, other than its price, changed cide how many hours you should study each subject. during the winter of 2014-2015. Treat each point on an exam as 1 unit of utility and as- a. If households in the Northeast increased their con sume that you consider an extra point on an econom- sumption of heating oil in the winter of 2014-2015, ics exam to have the same value as an extra point on a can we conclude that for these households, heating oil psychology exam. was a normal good? Briefly explain. b. Now suppose that you are a psychology major and that b. If households in the Northeast decreased their con- you value each point you earn on a psychology exam sumption of heating oil in the winter of 2014-2015, as being worth three times as much as each point you can we conclude that for these households heating oil earn on an economics exam. Now how many hours is an inferior good? Briefly explain. should you study each subject? c. If households in the Northeast decreased their con- sumption of heating oil in the winter of 2014-2015, can we conclude that for these households heating oil 1.9 (Related to Solved Problem 10.1 on page 324) Joe has $55 is a Giffen good? Briefly explain. o spend on apples and oranges. Given the information in Source: Jon Kamp, "Cheaper Hearing Oil Fuels Billions in Savings in the following table, is Joe maximizing utility? Briefly explain. Northeast," Wall Street Journal, January 16, 2015. Marginal Total Utility of 3.6 According to an opinion survey, Snoopy is the most Price Quantity Utility Last Unit appealing celebrity endorser. The beagle from the popular Apples $0.50 50 1,000 20 Peanuts comic strip appears in commercials for the insur- 30 ance company MetLife. What advantages and disadvan Oranges $0.75 40 500 tages are there in using Snoopy, rather than a real person, to endorse a product? 1.10 Maya spends her $50 budget on two goods, cans of tuna and Source: jeff Bercovici, "America's Most Loved Spokescharacters," bottles of ginger ale. Initially, the marginal utility per dollar Forbes, March 14, 2011. she spends on tuna is equal to the marginal utility per dol- lar she spends on ginger ale. Then the price of ginger ale decreases, while her income and the price of tuna do not 4.6 Richard Thaler, an economist at the University of change. Briefly explain whether each of the following state- Chicago, is the person who first used the term endowment ments about what happens as a result of the decrease in the effect to describe placing a higher value on something price of ginger ale is true or false. already owned than would be placed on the object if not a. Her marginal utility from consuming ginger ale increases. currently owned. According to an article in the Economist: b. The marginal utility per dollar she spends on ginger Dr. Thaler, who recently had some expen- ale increases. sive bottles of wine stolen, observes that he c. Because of the substitution effect, Maya will buy more is "now confronted with precisely one of my ginger ale. Therefore, we can conclude that ginger ale own experiments: these are bottles I wasn't is a normal good. planning to sell and now I'm going to get d. As Maya adjusts to the change in the price of ginger ale, a cheque from an insurance company and her marginal utility per dollar spent on tuna will increase. most of these bottles I will not buy. I'm a good enough economist to know there's a bit of an R. Glenn Hubbard / Andting inconsistency there." Based on Thaler's statement, how do his stolen bottles of 1 Bren . Micresumes wine illustrate the endowment effect, and why does he 6 the edition make the statement: "I'm a good enough economist to know there's a bit of an inconsistency there"? Source: "It's Mine, I Tell You," Economist, June 19, 2008