Transcript ECON 1001 AB Introduction to Economics I Dr. Ka

Chapter 5
Demand: The Benefit Side of the
Market
odd-number Questions
Problem #1, Chapter 5
• In which type of restaurant do you expect the service to be
more prompt and courteous: an expensive gourmet
restaurant or an inexpensive diner? Explain.
Solution to Problem #1 (1)
• Refer to chapter 1
– We discussed that the amount you are willing to spend on a certain
product reveals the value or the benefit of the product
– If you are rational and are willing to pay $800 for an admission ticket
to watch a concert, the value or benefit of the concert must be at least
$800
• In the question, two options are given: an expensive gourmet
restaurant and an inexpensive diner
• Both the restaurant and the diner are actually businesses
selling food and services
Solution to Problem #1 (2)
• In of terms of Economics goods, is “food” a normal good or an
inferior good?
– Food is both a necessity and a normal good. If your income increases,
you will probably increase your consumption in food or increase your
consumption in expensive food like premium beef and seafood
• In of terms of Economics goods, is “service” a normal good or
an inferior good?
– Service is also a normal good. If your income increases, you will
probably spend more on service or spend more on expensive service
like hiring a in-house maid to do all the housework or hiring an
professional accountant to look over your wealth management
Solution to Problem #1 (3)
• Thus, “Willingness to pay for FOOD”, and that for SERVICE are
increasing functions with income
• Expensive gourmet restaurants like those in ifc or in luxurious
hotels target on diners who earn higher incomes
• Inexpensive diners like those on campus target on diners who
earn lower incomes
Solution to Problem #1 (4)
• To attract diners earning higher incomes and charge them a
higher price, expensive gourmet restaurants provide high
quality of food as well as high quality of service
• To attract diners earning lower incomes and charge them a
lower price, inexpensive diners provide low quality of food as
well as low quality of service (self-serve on campus)
Problem #3, Chapter 5
• Martha’s current marginal utility from consuming orange juice
is 75 utils per ounce and her marginal utility from consuming
coffee is 50 utils per ounce. If orange juice costs 25 cents per
ounce and coffee costs 20 cents per ounce, is Martha
maximizing her total utility from the two beverages? If so,
explain how you know. If not, how should she rearrange her
spending?
Solution to Problem #3 (1)
• Notion of marginal utility
– The extra (additional) satisfaction one derives from one’s consumption
activities
– Thus, we can draw a parallel line between marginal utility and
marginal benefit
• We can solve this problem by applying the Rational Spending
Rule:
• Spending should be allocated across goods so that the marginal
utility per dollar is the same for each good
Solution to Problem #3 (2)
• Currently,
• The marginal utility from drinking orange juice per dollar
– = Marginal utility from consuming orange juice / Price per ounce
– = 75 utils / $0.25
– = 300 utils per dollar from her last dollar spent on orange juice
• The marginal utility from drinking coffee per dollar
– = Marginal utility from consuming coffee / Price per ounce
– = 50 utils / $0.20
– = 250 utils per dollar from her last dollar spent on coffee
Solution to Problem #3 (3)
• As the marginal utilities from consuming orange juice and
coffee are not the same, Martha has not maximized her total
utility from drinking orange juice and coffee
• To improve her total utility from consuming orange juice and
coffee, Martha should drink more orange juice and less coffee
• Why?
• Drinking more orange juice will drive down the marginal
utility from consuming orange juice per dollar
• Drinking less coffee will drive up the marginal utility from
consuming coffee per dollar
– Note utility is a decreasing function with consumption
Problem #5, Chapter 5
• Sue gets a total of 20 utils per week from her consumption of
pizza and a total of 40 utils per week from her consumption of
yogurt. The price of pizza is $1 per slice, the price of yogurt is
$1 per cup, and she consumes 10 slices of pizza and 20 cups
of yogurt each week.
• True and false: Sue is consuming the optimal combination of
pizza and yogurt.
Solution to Problem #5 (1)
• False
• To prove whether Ann is consuming an optimal combination
of pizza and yogurt, we need to check whether the Rational
Spending Rule holds in her case
• Rational Spending Rule holds if the marginal utilities per dollar
from the consumptive activities are the same
• Unlike Problem #3 in which marginal utilities of consumptive
activities are given, Problem #5 provides total utilities of
consumptive activities
• Thus, we can only come out with the average utilities per
dollar from consuming pizza and yogurt
Problem #7, Chapter 5
10
Price ($/gallon)
• For the demand curve
shown, find the total
amount of consumer surplus
that results in the gasoline
market if gasoline sells for
$2 per gallon
2
80
100
1,000s of gallons/yr
Solution to Problem #7 (1)
• Reservation price refers to the maximum price that one will
pay to buy a certain
• Consumer surplus refers to the difference between a buyer’s
reservation price for a product and the price actually paid
• For example, I am willing to pay $30 for a Ham and cheese
source sandwich sold at Starbucks for which it is sold for only
$20
– My reservation price is $30
– The actual price I have to pay is $20
– Consumer surplus = $30 - $20 = $10
Solution to Problem #7 (2)
• If we keep calculating the consumer surplus in such a way that
one’s reservation price minus the actual market price of
gasoline ($2), we will get a total consumer surplus that is equal
to the area under the demand curve but above the actual price
($2)
• Consumer surplus when the gasoline is $2 per gallon
– = ($10-$2) * 800,000 gallons * (1/2) = $320,000
• Consumer surplus when the gasoline is $0 per gallon
– = ($10-$0) * 100,000 gallons * (1/2) = $5,000,000
Solution to Problem #7 (3)
• Consumer’s surplus
– The area under the demand curve but above the
actual market price
– It is a triangle under a linear demand curve
Problem #9, Chapter 5
• Refer to Problem #8. Tom’s total utility is the sum of the utility
he derives from pizza and movie rentals. If these utilities vary
with the amounts consumed as shown in the table, and pizzas
and movie rentals are again consumable only in wholenumber amounts, how many pizzas and how many movie
rentals should Tom consume each week?
Solution to Problem #9 (1)
• To find the optimal combination of consumption in pizzas and movie
rentals, we need to calculate the total utility of each possible combination
of consumption on the two goods
• That is, the optimal combination yields the highest total utility among all
the affordable combinations.
Possible combinations of pizza
and movie rentals
Total $
per
week
Total utility
per week
0 slices of pizza, 8 movie rentals
$24
0 + 57 = 57
1 slice of pizza, 6 movie rentals
$24
20 + 57 = 77
2 slices of pizza, 4 movie rentals
$24
38 + 54 = 92
3 slices of pizza, 2 movie rentals
$24
54 + 46 = 100
4 slices of pizza, 0 movie rental
$24
68 + 0 = 68
Solution to Problem #9 (2)
• Based on the above table, Tom should consume 3 slices of
pizza and 2 movie rentals per week, as this is the optimal
combination yielding the maximum total utility (100)