CHAPTER 8: Utility & Demand

Question 1

What are consumption choices?

Answer 1

• Describes the choices you make as a buyer of goods and services
• Influenced by consumption possibilities & preferences

Question 2

What are consumption possibilities & what are they limited by?

Answer 2

• Consumption possibilities - all the things you can afford to buy
  ○ Limited by your income & the prices you must pay for a good

Question 3

A budget line describes the boundary______.

Answer 3

between those combinations of goods & services that you can afford to buy & those you cannot afford

Question 4

What points of the budget line are affordable & which points are not?

Answer 4

can afford all points on budget line & inside it; Points outside budget line are unaffordable

Question 5

The budget line change when ____ & ____ changes. Give examples.

Answer 5

income & price
§ Rise in income shifts budget line outwards, leaves slope unchanged
§ Rise in price changes the slope of the line

Question 6

What are preferences? How are they used in theories of consumer choice?

Answer 6

Preferences - description of likes & dislikes
Goal of a theory of consumer choice is to derive the demand curve from a deeper account of how consumers make their buying plans

Question 7

What is utility?

Answer 7

benefit/satisfaction received from the consumption of goods & services

Question 8

What is total utility?

Answer 8

total benefit received from the consumption of all different goods & services

Dependent on level of consumption - more consumption, more total utility

Question 9

What is marginal utility?

Answer 9

change in total utility that results from one-unit increase in the quantity of a good consumed

□ E.g. If Lisa increases the cola she buys from 1 to 2 cases a month, her total utility from cola increases from 75 units to 123 units
□ Marginal utility from the second case is 48 units (123-75)

Question 10

T/F: marginal utility is positive

Answer 10

Yes, diminishes as the quantity of a good consumed increases

Question 11

What is diminishing marginal utility?

Answer 11

tendency for marginal utility to decreases as the consumption of a good increases

□ E.g. as Lisa sees more movies, her total utility from movies increases but her marginal utility from movies decreases

Question 12

What is consumer equilibrium?

Answer 12

consumer has allocated all of her available income in a way that maximizes her total utility, given the prices of goods & services

Question 13

What is marginal utility per dollar?

Answer 13

marginal utility from a good that results from spending one more dollar on it
○ Calculated by dividing marginal utility from a good by its price - MU/$

Question 14

Consumer total utility is maximized when….

Answer 14

○ Spend all the available income
○ Equalize the marginal utility per dollar

Question 15

How do we equalize marginal utility per dollar?

Answer 15

Move dollars from good B to good A, if doing so increases the utility from good A by MORE than it decreases the utility from good B
Buying more of good A decreases marginal utility
Buying less of good B increases its marginal utility

Question 16

What does marginal utility theory predict?

Answer 16

a fall in the price of a substitute of a good decreases the demand for the good and that for a normal good, a rise in come increases demand

Question 17

How is the paradox of value resolved?

Answer 17

Resolved by distinguishing between total utility & marginal utility

• E.g. total utility of water is large, but the more we consumer the smaller the marginal utility

○ E.g. diamonds have a small total utility (relative to water), but we consume lesser quantities of it. Therefore, diamonds have a high marginal utility

Question 18

What is behavioural economics?

Answer 18

a study of the ways in which limits on the human brain’s ability to compute and implement rational decisions influences economic behaviour

Question 19

According to behavioural economics, what 3 impediments prevent rational choice?

Answer 19

i. Bounded Rationality - limited by the computing power of the human brain
□ Difficult to work out rational choice - people use heuristics, listen to others pov, & rely on gut instinct to make choice

ii. Bounded Willpower - less-than-perfect willpower that prevents us from making a decision that we know, at the time of implementing the decision, we will later regret

iii. Bounded Self-Interest - limited self-interest that results in sometimes suppressing our own interests to help others

Question 20

What is the endowment effect?

Answer 20

tendency for people to value something more highly simply because they own it

Question 21

What are neuroeconomics?

Answer 21

study of the activity of the human brain when a person makes an economic decision

Question 22

Explain findings from neuroeconomics.

Answer 22

○ Prefrontal cortex - store memories, analyze data, & anticipate consequences of our actions
§ Active when making rational utility-maximizing decisions

○ Hippocampus - store memories of anxiety & fear
§ Decisions not rational; influenced by fear or panic

○ Dopamine - quantity increases in response to pleasurable events & decreases in response to disappointing events

Question 23

Which of the following statements illustrate​ Lisa’s preferences​?
A. Lisa buys 2 kilograms of chicken and 1 bag of rice from the grocery store.
B. Lisa drives her kid to school every morning.
C. Lisa negotiates with the plumber to fix her sink.
D. Lisa supplies designer clothes to her​ aunt’s boutique.

Answer 23

A

Question 24

Utility is the benefit or satisfaction that a person gets from the​ _____ of a good or service. The total utility is the total benefit that a person gets from the​ _____ of a good or service. Total utility​ _____ as the quantity​ _____ increases.
A. ​supply;​supply; increases; supplied
B. ​price;​price; increases; consumed
C. ​cost;​cost; decreases; supplied
D. ​consumption; ​consumption; increases; consumed

Answer 24

D

Question 25

The total utility obtained from three packs of potato chips is 36 units and the total utility obtained from two packs is 32 units. The marginal utility from the third pack is​ _____ unit(s).
A. 1
B. 12
C. 32
D. 4

Answer 25

D

Question 26

Explain how a​ consumer’s income and the prices of goods limit consumption possibilities. A change in the prices of goods​ _______ and a change in a​ consumer’s income​ _______.
A. shifts the budget​ line; has no effect on the budget line
B. has no effect on the budget​ line; changes the slope of the budget line
C. shifts the budget​ line; changes the slope of the budget line
D. changes the slope of the budget​ line; shifts the budget line

Answer 26

D

Question 27

What is the key assumption about marginal​ utility? The key assumption about marginal utility is that marginal utility​ _______.
A. reaches a minimum value and then increases with further consumption
B. eventually equals total utility
C. decreases as consumption increases
D. can never be negative

Answer 27

C

Question 28

A consumer equilibrium is a situation in which a consumer has allocated​ _____ of her income in a way that​ _____.
A. ​all; maximizes her total utility
B. ​some; increases her marginal utility
C. ​some; lowers her household budget
D. ​all; maximizes her marginal utility

Answer 28

A

Question 29

Tina’s marginal utility from a notebook is 42 units. At a price of​ $8 per​ notebook, what is the marginal utility per dollar from a​ notebook?
A. ​$8
B. ​$4
C. ​$5.25
D. ​$3.50

Answer 29

C

Question 30

If the marginal utility per dollar from video games exceeds the marginal utility per dollar from hot​ chocolate, play​ _______ video games and buy​ _______ hot chocolate to maximize total utility.
A. ​more; more
B. ​fewer; more
C. ​more; less
D. ​fewer; less

Answer 30

C