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Answers to Text Questions and Problems
Answers to Review Questions
1. The law of diminishing marginal utility says that the first units we consume of a good deliver the
highest “bang for the buck,” and this means that we can generally achieve higher utility by spreading our
incomes over many goods than by concentrating them on only a few.
2. If the demand for a product is elastic with respect to its price, an increase in price will lead to a
reduction in total spending for that product.
3. Because the algebraic sign of the elasticity of demand for a good with respect to its own price is
always negative, knowing that sign conveys no useful information. In contrast, the elasticity of demand
for a good with respect to the price of another good can be either positive or negative, so it is important to
keep track of the sign.
4. The elasticity of demand at any point is the price-quantity ratio at that point multiplied by the
reciprocal of the slope of the demand curve. The slope, and hence its reciprocal, is constant along a
straight-line demand curve, but the price-quantity ratio—and hence the price elasticity of demand—
declines as we move down the curve.
5. If the cross-price elasticity of demand for firewood with respect to the price of fuel oil is positive,
and the price of fuel oil rises, then the quantity demanded of firewood will rise, as consumers will use less
fuel oil for their heating and cooking needs and will use more firewood. The demand curve for firewood
will shift to the right, as more firewood is demanded at any given price.
6. Since developing countries have lower incomes than industrial countries, and motor scooters are
used for transportation in developing countries, then motor scooters must be inferior goods. Once
countries’ incomes rise, consumers switch to automobiles for transportation. Automobiles are thus normal
goods.
Answers to Problems
1. Because the willingness to pay for food quality is likely to be an increasing function of income, we
expect patrons of the gourmet restaurant to have higher incomes, on average, than patrons of the diner.
And since willingness to pay for service is also likely to be an increasing function of income, we expect
higher quality service in the gourmet restaurant. Since diners tend to leave tips of about 15 percent of the
prices of their meals, gourmet restaurant patrons do, in fact, pay for and receive higher quality service.
2. Mila is currently receiving (75 utils/30 mL)/($0.25/30 mL)= 300 utils per dollar from her last dollar
spent on orange juice, but only (50 utils/30 mL)/($0.20/30 mL) = 250 utils per dollar from her last dollar
spent on coffee. Since the two are not equal, she is not maximizing her utility. She should spend more on
orange juice and less on coffee.
3a.
P
($/pack)
6
elastic
5
4
inelastic
3
2
1
Q (1000s of packs/day)
3
b.
c.
d.
e.
f.
g.
6
9
12
15
18
P = 6 – Q/3, where P is price per pack in dollars and Q is thousands of packs per day.
Elasticity = (1/slope)(P/Q). When P = 3, Q = 9; 1/slope is 3. So elasticity = 3(3/9) = 1.0.
If the price increases from $3 to $4, total revenue will fall from $27,000 to $24,000.
Using the same formula as in (c), elasticity = 3(2/12) = 0.5.
If the price increases from $2 to $3, total revenue will rise from $24,000 to $27,000.
The region of the demand curve above P = 3 is elastic, and the region below P = 3 is inelastic.
4a. If fewer student loans are available, then we would expect to see higher demand for credit cards by
students.
b. An increase in demand leads to a higher price and a higher quantity, so we would expect to see a
higher quantity of credit cards issued to students, and a higher willingness of students to incur debt at
higher interest rates.
c. Yes, credit cards are a substitute for student loans. We would expect to see a positive cross-price
elasticity of demand.
5a. Since the quantity of wine consumed has increased as incomes have risen, the income elasticity of
demand for wine must be positive. Since the quantity of beer consumed has not changed, the income
elasticity of demand for beer must be close to zero.
b. A positive income elasticity of demand for wine would indicate that wine is a normal good. A zero
income elasticity of demand for beer would indicate that beer is neither normal nor inferior.
c. Considering only this information, it would appear that prescription drugs are an inferior good, since
consumption increases as incomes fall.
d. As people age, their marginal utility and demand for prescription drugs tends to increase. This would
explain the increasing consumption of prescription drugs in (c), rather than falling incomes.
6. The price elasticity of a good generally increases with the number of substitutes it has. It is easier to
substitute a Ford or Toyota for a Chevrolet than it is to substitute a motorcycle or a skateboard for a car.
Thus the market demand curve for cars is likely to be less elastic with respect to price than the market
demand curve for Chevrolets.
7. The absolute value of the slope of this demand curve is 1/3, so plugging in the P and Q values at
point A into the formula elasticity = (1/slope)(P/Q), we have elasticity at A = 3(4/6) = 2. Since demand is
elastic at this point, a 1 percent increase in price will result in a 2 percent fall in quantity demanded, and
total revenue will thus fall.
8a. Demand is likely to fall, implying a shift left in the demand curve and a negative income elasticity of
demand.
b. Demand is likely to rise, implying a shift right in the demand curve and a positive income elasticity
of demand.
c. Demand is likely to rise, implying a shift right in the demand curve and a positive income elasticity
of demand.
d. Demand is likely to fall, implying a shift left in the demand curve and a negative income elasticity of
demand.
9a. Automobiles and tires are complements, as they are used in combination. The cross-price elasticity
is negative: if the price of automobiles rises, the demand curve for tires will shift left, and the equilibrium
quantity will fall.
b. Air travel and hotel rooms are complements, as they are used in combination. The cross-price
elasticity is negative: if the price of air travel rises, the demand curve for hotel rooms will shift left, and
the equilibrium quantity will fall.
c. Milk and soft drinks are substitutes, as they serve similar functions. The cross-price elasticity is
positive: if the price of milk rises, the demand curve for soft drinks will shift right, and the equilibrium
quantity will rise.
d. Music downloaded from the internet and music recorded on CDs are complements, as they serve
similar functions. The cross-price elasticity is positive: if the price of music downloaded from the internet
rises, the demand curve for music recorded on CDs will shift right, and the equilibrium quantity will rise.
Sample Homework Assignment
1. Assume that you derive utility from the consumption of two goods, hamburgers and CDs. The utility
you receive from each good at various levels of consumption is shown in the table below.
Hamburgers
Number
0
1
2
3
4
5
6
7
8
9
10
a.
b.
c.
2.
a.
b.
c.
Total utility
0
30
55
75
90
103
113
121
127
127
125
CDs
Number
0
1
2
3
4
5
6
7
8
9
10
Total utility
0
30
50
60
65
70
72
73
74
74
74
If you have $50 to spend, and the price of CDs is $10 while the price of hamburgers is $5, determine
the utility maximizing combination of hamburgers and CDs. Assume that only whole numbers of
CDs and hamburgers can be purchased.
What does the information in the table tell you about the 9th and 10th CDs?
What does the information in the table tell you about the 10th hamburger?
You operate your own business selling university t-shirts. The demand schedule for your t-shirts is
as follows: P = 25 – 0.5Q.
Graph the demand curve for your t-shirts.
Calculate the price elasticity of demand when price equals $10.
In what range does price elasticity of demand fall at $10 (elastic, unit elastic, inelastic)?
d.
If your goal is to maximize total revenue, how should you change the price if you are currently
charging $10?
3.
What happens to the price elasticity of demand for snow shovels the night before a
big snow storm is forecast to hit a city? Explain.
Multiple Choice Quiz
1.
a.
b.
c.
d.
e.
If an increase in border patrols decreases the supply of illicit drugs, which of the following is
expected?
A decrease in the price of illicit drugs.
An increase in the quantity of illicit drugs.
A decrease in drug-related crime.
An increase in the total amount spent on drugs.
All of the above.
2.
a.
b.
c.
d.
e.
The law of demand
says that people do less of what they want to do as the cost of doing it rises.
is not related to the cost-benefit principle.
describes a positive relationship between price and quantity demanded.
excludes non-monetary costs.
all of the above.
3.
a.
b.
c.
d.
e.
Which of the following describes the law of diminishing marginal utility?
The more you consume, the happier you are.
As you consume more, your level of happiness falls.
As prices fall, you enjoy consuming more.
You enjoy the first units you consume more than later units.
An increase in income increases your happiness.
4.
a.
b.
c.
d.
e.
Which of the following happens as a result of an increase in income?
Demand increases
Prices fall
Total utility decreases
Marginal utility increases
All of the above
5.
a.
b.
c.
d.
e.
If the price of new cars falls, what will happen to the demand for used cars?
Remain the same
Increase
Decrease
Shift to the right
Become more inelastic
6.
a.
b.
c.
d.
e.
Which of the following explains why automobile engines are smaller in Europe than in North
America?
Income is higher in North America
Income is higher in Europe
The price of gasoline is higher in North America
The price of gasoline is higher in Europe
Gasoline taxes in Europe are relatively low
7.
Refer to the graph below.
Price
100
50
Demand
200
400
Quantity
Which of the following is correct?
a. The slope of the demand curve is –0.25.
b. The vertical intercept of the demand curve is 50.
c. The vertical intercept of the demand curve is 400.
d. The equation of the demand curve is: P = 100 – 4Q.
e. The equation of the demand curve is: Q = 100 – 4P.
8.
a.
b.
c.
d.
e.
Which of the following goods will have the most inelastic demand?
A Burger King hamburger
A can of generic brand peaches
Prescription medication
Food in the campus dining hall
A particular section of an economics class at a large university
9.
Which of the following is not a determinant of price elasticity of demand?
a.
b.
c.
d.
e.
Substitute possibilities
Budget share
Time
All of the above are determinants of price elasticity of demand
None of the above is a determinant of price elasticity of demand
10.
a.
b.
c.
d.
e.
Which of the following is true if income elasticity of demand is positive for goods X and Y?
They are substitutes.
They are complements.
They are normal goods.
They are inferior goods.
Their demands are elastic.
Problems/Short Answer
1.
a.
b.
2.
a.
b.
c.
Your current marginal utility from consuming pop is 400 utils per mL and your current marginal
utility from consuming milk is 600 utils per mL.
If the price of pop is $0.07 per mL and the price of milk is $0.25 per mL, are you maximizing your
total utility from pop and milk? Explain.
What would happen to your total utility from pop and milk if you increased your consumption of
milk and decreased your consumption of pop? Explain.
You operate your own business selling university t-shirts. The demand schedule for your t-shirts is
as follows: P = 10 – 0.5Q.
Graph the demand curve given.
Calculate the price elasticity of demand if the price of t-shirts is $5.
Use your answer in part (b) to explain what will happen to your total revenue if you increase the
price of your t-shirts above $5.
Answer Key to Extra Questions in Instructor’s Manual
Sample Homework Assignment
1.
The MU and MU/P from consuming hamburgers and CDs is shown below.
Hamburgers
Number
1
2
Marginal
utility
30
25
MU/P
CDs
Number
30/5 = 6
25/5 = 5
1
2
Marginal
utility
30
20
MU/P
30/10 = 3
20/10 = 2
3
4
5
6
7
8
9
10
20
15
13
10
8
6
0
-2
20/5 = 4
15/5 = 3
13/5 = 2.6
10/5 = 2
8/5 = 1.6
6/5 = 1.2
0
-2/5 = -0.4
3
4
5
6
7
8
9
10
10
5
5
2
1
1
0
0
10/10 = 1
5/10 = 0.5
5/10 = 0.5
2/10 = 0.2
1/10 = 0.1
1/10 = 0.1
0
0
a. 6 hamburgers and 2 CDs each provide marginal utility per dollar of 2, and completely use up the $50
income ($5 × 6 + $10 × 2 = $50), so this is the utility-maximizing combination of goods.
b. Neither the 9th nor the 10th CDs add to your total utility; your utility stays the same after consuming
them.
c. You have less utility after consuming the 10th hamburger than you did before (the 10th hamburger
decreased your happiness).
2a.
Price
25
20
15
10
Demand
10
b.
c.
d.
20
30
50
Quantity
Elasticity = P/Q (1/slope) = 10/30 (1/0.5) = 10/15 = 0.67.
Inelastic (less than 1).
When demand is inelastic, you should raise price in order to increase total revenue.
3. Demand becomes more inelastic; consumers have little time to shop around for a shovel since they
will need it for the snowstorm predicted for the following day.
Multiple Choice
1.
2.
3.
4.
5.
6.
d
a
d
a
c
d
7.
8.
9.
10.
a
c
d
c
Problems/Short Answer
1a. (MU/$)pop = 400/0.07 = 5714. (MU/$)milk = 600/0.25 = 2400. Since the marginal utility per dollar
spent on pop is higher than the marginal utility per dollar spent on milk, MU/$ is not equal; therefore,
total utility is not being maximized.
b. Increasing milk consumption would decrease the marginal utility of milk (due to the law of
diminishing marginal utility) and increase the marginal utility of pop. This would make the marginal
utility per dollar even more unequal and would therefore decrease total utility.
2a.
Price
10
7.50
5
2.50
Demand
5
10
15
20
Quantity
b. Elasticity = P/Q (1/slope) = 5/10 (1/0.5) = 1.
c. Since elasticity equals 1 at a price of $5, elasticity will be greater than 1 at higher prices. Total
revenue will therefore fall if the price is increased, because elastic demand means that the higher price
cannot make up for the reduced quantity.