Download 4 - Ghulam Hassan

Chapter 7
Consumer Behavior
 Utility is the benefit or satisfaction that a person receives from
continuing a good or a service.
 The law of diminishing marginal utility indicates that gains in
satisfaction become smaller as successive unit of a specific product are
consumed.
 Diminishing marginal utility provides a simple rational for the law
of demand.
 The theory of consumer behavior assumes that, with limited
income and a set of product prices, consumer make rational choices on
the bases of well-defined preferences.
 A consumer maximizes utility by allocation income so that the
marginal utility per dollar spent is the same for everyone.
 A downward-sloping demand curve can be derived by changing
the price of one product in the consumer-behavior model and noting
the change in utility-maximization quantity of that product demanded.
 By providing insights on the income effect and substitution effect
of a price decline, the utility-maximization modal helps explain why
demand curves are down-sloping.
MCQ’s on “Consumer Behavior”
I.
The utility of a particular good:
o is the same for everyone, even if its usefulness differs from
person to person
o is a measure of the product's usefulness
o increases at a constant rate
o increases at a decreasing rate
II. Answer the next question on the basis of the following two
schedules, which show the amounts of additional satisfaction (marginal
utility) that a consumer derives from successive quantities of products J
and K. Refer to the table. If this consumer has an income of $26 and the
prices of J and K are $2 and $4 respectively, the consumer will maximize
her utility by purchasing:
o 7 units of J and 3 units of K
o 5 units of J and 4 units of K
o 3 units of J and 5 units of K
o 1 units of J and 6 units of K
III. Jim enjoys having either a peanut butter sandwich or a bologna
sandwich for his lunch. A drop in the price of peanut butter increases
the marginal utility per dollar of peanut butter and causes Jim to buy
more peanut butter and less bologna to restore maximum utility. This
best illustrates the:
o Law of diminishing marginal utility
o Income effect
o Substitution effect
o Law of increasing total utility
IV. Suppose the prices of products X and Y are $5 and $10,
respectively. For a specific consumer who is currently exhausting her
total income, the total utility from X is 100, while the total utility from Y
is 200. The marginal utility of X and Y are both equal to 8. From this
information, we can conclude:
o She is maximizing total utility
o She should purchase relatively more x
o She should purchase relatively more y
o
Nothing about whether she is maximizing total utility
V. Suppose the price of an iced coffee is $4 and the price of a candy
bar is $2. In order to maximize total utility, a consumer who buys some
of each should allocate purchases such that:
o The marginal utility of each good is the same
o The marginal utility of an iced coffee is half that of a candy bar
o The marginal utility of an iced coffee is twice that of a candy bar
o The total utility of an iced coffee is half that of a candy bar
VI. Kevin received 80 total units of utility from the first four chips he
consumed. If the marginal utilities of the first, second, and third chips
are 20, 25, and 20, respectively, the marginal utility of the fourth chip
is:
o 5 units of utility
o 20 units of utility
o 15 units of utility
o Unknown, since Kevin's utility does not conform to the usual rules
VII. Jacque and Sharif have identical preferences but Sharif has a
lower opportunity cost of time. We should expect that, compared to
Jacque, Sharif:
o Will have a higher marginal utility of income
o Will have a higher total utility of income
o Will consume fewer time-intensive commodities
o Will consume more time-intensive commodities
VIII. Joan occasionally enjoys wine with her meals. However, the more
wine she consumes per month, the lower her marginal utility of wine.
We can conclude that:
o Joan's demand for wine is inelastic
o Joan's demand for wine is downward sloping
o An decrease in the price of wine will decrease Joan's total utility
o A decrease in the price of wine will increase Joan's marginal utility
IX. The price of apples decreases and Josh responds by buying more
apples and fewer oranges. Accordingly, the:
o Marginal utility of both apples and oranges will decrease
o Marginal utility of both apples and oranges will increase
o Marginal utility of apples will increase and the marginal utility of
oranges will decrease
o Marginal utility of apples will decrease and the marginal utility of
oranges will increase
X.
Which of the following is consistent with maximum utility:
The marginal utility of each product is the same
The total utility of each product is the same
The marginal utility of each product is zero
o
o
o
o The marginal utility per dollar of each product is the same
Problems on Consumer Behavior
Problem 1:
Suppose Maria's preferences for eggs and milk can be described by the
following marginal utility schedules. Both eggs and milk cost $4; Maria
has allocated $16 to the purchase of these two products.
Unit of
Products
First
Second
Third
Fourth
Fifth
Sixth
Egg
Marginal
Utility
24
20
16
12
8
4
Milk
Marginal
Utility
36
30
24
18
12
6
a) How should Maria allocate her $16 between eggs and milk so as
to achieve maximum utility?
b) Verify that the marginal utility per dollar of each good is the same
at the utility maximizing bundle.
c) Suppose the price of eggs falls to $2. By comparing the marginal
utility per dollar of her current purchases of eggs and milk, should
Maria purchase more eggs, more milk, or does her current bundle still
maximize her utility?
d) Assuming Maria still allocates $16 between the two goods, what
amounts of eggs and milk maximize her utility at these new prices?
e) From the exercises above, list two price/quantity combinations
that lie on Maria's demand curve for eggs.
Answer:
a) At the given prices, find the marginal utility per dollar for each
good by dividing marginal utility by price. This results in the table
below.
Egg
Milk
Unit of
MU Per
Marginal
MU Per
Marginal
Products
Dollar
Utility
Dollar
Utility
First
6
24
9
36
Second
5
20
7.5
30
Third
4
16
6
24
Fourth
3
12
4.5
18
Fifth
2
8
3
12
Sixth
1
4
1.5
6
The first unit of milk yields the biggest increase in utility per dollar, and
uses $4 from the budget. The second unit of milk is still better than the
first unit of eggs, and uses another $4. Either the first unit of eggs or
the third unit of milk yields the same increase in utility per dollar. With
$8 left in the budget, purchase one of each. Three units of milk and
one unit of eggs maximize Maria's utility.
b) The marginal utility per dollar on the first unit of eggs is 6 utils,
the same as the marginal utility per dollar of the third unit of milk.
c) At her current levels of consumption, the marginal utility per
dollar of eggs rises to $12,
Egg
Milk
Unit of
MU Per
Marginal
MU Per
Marginal
Products
Dollar
Utility
Dollar
Utility
First
12
24
9
36
Second
10
20
7.5
30
Third
8
16
6
24
Fourth
6
12
4.5
18
Fifth
4
8
3
12
Sixth
2
4
1.5
6
In excess of her marginal utility per dollar of milk, this remains at $6.
She should purchase relatively more eggs.
d) Her current purchases now use only $14. She could use the extra
two dollars to purchase the second unit of eggs, since its marginal
utility per dollar (10) is now higher than the marginal utility per dollar
of milk (still 6). Further, if Maria cuts back her purchases of milk to two
units, she sacrifices 24 utils of satisfaction but frees up $4. She could
use this $4 to purchase the third and fourth units of eggs, gaining 16
utils of satisfaction on the third and 12 utils of satisfaction on the
fourth, for a net gain of 4 utils of satisfaction on the switch. Her new
consumption bundle is then 4 units of eggs and 2 units of milk.
e) When the price of eggs is $4, Maria demands 1 unit; at a price of
$2, Maria demands 4 units.
Questions on Consumer Behavior
Question 1:
Complete the following table and answer the questions below:
a) At which rate is total utility increasing: a constant rate, a
decreasing rate, or an increasing rate? How do you know?
b) "A rational consumer will purchase only 1 unit of the product
represented by these data since that amount maximizes marginal
utility." Do you agree? Explain why or why not.
c) "It is possible that a rational consumer will not purchase any units
of the product represented by these data." Do you agree? Explain why
or why not.
Answer:
Units consumed
Total utility
Marginal utility
0
0
1
10
10
2
18
8
3
25
7
4
30
5
5
33
3
6
34
1
a) A decreasing rate; because marginal utility is declining.
b) Disagree. The marginal utility of a unit beyond the first may be
sufficiently great (relative to product price) to make it a worthwhile
purchase. Consumers are interested in maximizing total utility, not
marginal utility.
c) Agree. This product’s price could be so high relative to the first
unit’s marginal utility that the consumer would buy none of it
Question 2:
Columns 1 through 4 in the table show the marginal utility, measured in
utils, that Ricardo would get by purchasing various amounts of products
A, B, C, and D. Column 5 shows the marginal utility Ricardo gets from
saving. Assume that the prices of “A, B, C, and D” are $18, $6, $4, and
$24, respectively, and that Ricardo has an income of $106.
a) What quantities of A, B, C, and D will Ricardo purchase in
maximizing his utility?
b) How many dollars will Ricardo choose to save?
c) Check your Answer by substituting them into the algebraic
statement of the utility-maximizing rule.
Answer:
a) Answers are following:
Product
Quantity
A
4
B
3
Formula
𝐌𝐔𝐀
𝐏𝐀
𝐌𝐔𝐁
𝐏𝐁
𝟑𝟔
=𝟐
$𝟏𝟖
𝟏𝟐
=𝟐
$𝟔
C
3
D
0
𝐌𝐔𝐂
𝐏𝐂
𝐌𝐔𝐃
𝐏𝐃
𝟖
=𝟐
$𝟒
b) At Product A = 72 (18x4), At Product B = 18 (6x3), At Product C =
12 (4x3), At Product D = 0 (0x0) So, saving is $4.
c)
𝐌𝐔𝐀
𝐌𝐔𝐁
𝐌𝐔𝐂
𝐌𝐔𝐃
=
=
=
𝐏𝐀
𝐏𝐁
𝐏𝐂
𝐏𝐃
36
12
8
2
=
=
=
$18
$6
$4 $1
The marginal utility per dollar of the last unit of each product
purchased is 2.
Question 3:
You are choosing between two goods, X and Y, and your marginal utility
from each is as shown in the table below. If your income is $9 and the
prices of X and Y is $2 and $1, respectively:
a) What quantities of each will you purchase to maximize utility?
b) What total utility will you realize?
c) Assume that, other things remaining unchanged, the price of X
falls to $1. What quantities of X and Y will you now purchase?
d) Using the two prices and quantities for X, derive a demand
schedule (price-quantity-demanded table) for X.
Answer:
a) Buy 2 units of X and 5 units of Y.
spent will be equal at 4:
𝐌𝐔𝐱
=
𝐏𝐱
8
=
$2
Marginal utility of last dollar
𝐌𝐔𝐲
𝐏𝐲
4
$1
And the $9 income will be spent.
b) Total utility = 48. (18 for X + 30 for Y)
Units of X T.Utility
MUX
Units of Y T.Utility
MUy
1
10
10
1
8
8
2
18
8
2
15
7
3
24
6
3
21
6
4
28
4
4
26
5
5
31
3
5
30
4
6
33
2
6
33
3
c) When the price of X falls to $1, the quantity of X demanded
increases from 2 to 4 (income effect).
𝐌𝐔𝐲
𝐌𝐔𝐱
=
𝐏𝐱
𝐏𝐲
4
4
=
$1
$1
Total utility is now 58 (28 for X + 30 for Y)
Units of X T.Utility
MUX
Units of Y T.Utility
1
10
10
1
8
2
18
8
2
15
3
24
6
3
21
4
28
4
4
26
5
31
3
5
30
6
33
2
6
33
d) Demand schedule for X: P = $2; Q = 2. P = $1; Q = 4.
MUy
8
7
6
5
4
3