General Instructions for all Assignments: Read the following chapters in the text: Krugman, P., " Wells, R. (2015). Microeconomics (4th ed.). New York, NY: Worth Publishers. Kaplan.vitalsource.com. Retrieved from https://kaplan.vitalsource.com/#/books/9781464144820/
Chapter 6: “Elasticity”
Chapter 10: “The Rational Consumer”
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Assignment
In this Assignment, you will focus on marginal utility, Price Elasticity of Demand, and understanding the difference between Price Elasticity of Demand and Income Elasticity of Demand.
We all subconsciously assign “scores” to what we are considering to purchase, based on our expected level of “satisfaction” (Marginal Utility) with that purchase. When making simultaneous pairs of purchases, again we subconsciously compare the amount of “satisfaction” (Marginal Utility) that we will receive from the pair of purchases. To decide on the “ideal” combination of these two purchases, we expect that the last dollar we spend on each of the items will give us the “same” satisfaction per dollar (Marginal Utility per dollar). Further, we know that the MORE of an item that we get, the next one we get will give us LESS “satisfaction” Marginal Utility) than the last one gave us (the Law of Diminishing Marginal Utility). Using what you have learned about Marginal Utility and Marginal Utility per dollar, answer the following questions.
Questions
1. Jane has been working all day, missing both her breakfast and lunch. Finally able to leave work, after being required to work a couple of hour’s overtime, she is starving. Jane has $20 in her pocket, so she stops at a local fast food restaurant and orders a grilled chicken sandwich (somewhat healthy) and fries (not so healthy). As she sits down to eat them, a University student approaches her and tells her that she is doing a research project for her microeconomics course, and would like to ask Jane a few quick questions. Jane agrees and the student asks what “score” (Marginal Utility) from 1 to 100 would she give as her satisfaction level with the 1st sandwich and the 1st
fries? After eating that order, Jane is still hungry and orders a second chicken sandwich and another fries. Again, the student asks Jane to give her new scores. Since Jane has not eaten all day, she is hungry enough to order a third round of food and again gives “scores” to the inquisitive student.
Below is the University student’s completed experiment tally sheet of Jane’s marginal utility “scores” and the calculation of her marginal utility per dollar, given that each sandwich costs $4.00 and each order of fries costs $2.00, along with her budget of $20. The student filled in the shaded cells based on Jane’s responses, then computed the values in the remaining cells. Using this information, answer the following questions:
a. Is Jane maximizing her utility? Explain your reasoning and show any calculations.
No, she does not seem to be maximizing her utility because marginal utility for each dollar spent on the last chicken is not the same as the marginal utility of each dollar spent on the last fries. This is illustrated below:
Marginal utility per dollar for the chicken sandwich is given by:
60÷4, this is equal to 15.
The marginal utility per dollar for the fries is given by:
6÷2, this is equal to 3
Now:
15 is not equal to 3
b. If Jane is not maximizing her utility, remembering the Law of Diminishing Marginal Utility, would she be better off to buy one less chicken sandwich and one more fry? Explain your reasoning and show any calculations.
The answer is no, she wouldn’t be better off. The marginal utility of fries will tend towards the negative as that of chicken will decrease to eighteen but still be positive therefore increasing the difference between the marginal utilities of the two foods.For her to be better off the difference between marginal utilities per dollar of the two foodstuffs must decrease. This is illustrated below:
Mu/$ chicken sandwich₌ 72÷4₌18.Now assuming the Mu of the fourth fries₌3, the Mu/$₌3÷2=1.5
This increases the differences between the marginal utility per dollar of the two commodities
c. If Jane is not maximizing her utility with the original purchase combination, remembering the Law of Diminishing Marginal Utility, would she be better off buying just one more fry? Explain your reasoning and show any calculations.
No, still she wouldn’t be sitting in a better position, the marginal utility per dollar of the chicken sandwich would still be at fifteen while that of the fries will tend towards the negative hence increasing the difference between the marginal utility per dollar of the two foodstuffs keeping in mind she will move further away from utility maximization point where the marginal utility per dollar of the two foodstuffs happens to be the same
d. If Jane is not maximizing her utility with the original purchase, remembering the Law of Diminishing Marginal Utility, would she be better off buying one less
fries and one more chicken sandwich? Explain your reasoning and show any calculations.
Yes, she would be better off. The marginal utility per dollar of the fries would be
20÷2 = 10.
However, the marginal utility of the fourth chicken would be;
60-6 = 54
Hence marginal utility per dollar of the chicken would be;
54÷4 =13.5
The difference in marginal utility per dollar would now be;
13.5-10 =3.5
Hence closer to zero where utility maximization is achieved hence she is better off.
2. Remembering the Learning Practice in Unit 3, in the year 107 WBCE (Way Before the Common Era) the Gondwanaland Chairman of Production reported that the gosum berry growers were able to meet an average demand of 700 barrels of gosum berries per month at an average a price of $70 per barrel.
In the year 108 WBCE the growers were plagued with a gosum berry bug infestation that reduced average output, causing production to fall to only 600 barrels per month, causing the price to rise to $84 per barrel. The following table shows the Chairman’s report:
Year (WBCE)
Monthly barrels of gosum berries demanded
Price per barrel
107
700
$70
108
600
$84
a. Using the midpoint method, calculate the price elasticity of demand for Gondwanaland gosum berries. Explain what this price elasticity of demand means?
The analysis table is given below
Year
price
Quantity
Revenue
107
$70
700
$49000
108
$80
600
$48000
(Price elasticity of demand) ₌ [{Q2-Q1}÷ {Q2+Q1}÷2} ÷ {{P2-P1}÷{P2+P1}÷2
{{600-700}÷{600+700} ÷2}÷ {{80-70}÷{80+70}÷2}
= 1.1538
This price elasticity of demand is more than 1 and is elastic which means that increasing the price leads to many customers stopping the purchase of the commodity in question hence a decline in the revenues.
b. What is the monthly average total revenue for year 107, and the monthly average total revenue for year 108? How do these numbers compare to each other?
Year{WBCE}
Monthly barrels of gosum berries demanded
Price per barrel
Monthly average total revenue
107
700
70
$49000
108
600
80
$48000
Change in total revenue
$1000
Therefore the monthly average total revenue for the year is 107 WBCE IS $49000 while that for year 108 is $48000.The monthly average total revenue for year 108 WBCE is less by $1000 to that of year 107 WBCE.
c. Using your answer to part a. above, how could you have predicted this change in total monthly revenue?
The price elasticity of demand is found to be 1.1538
Percentage change in in revenue = 1.1538 ×100 × {(70×700)÷(80×600)}
= $1000
3. The Gondwanaland Chairman of Production reported that the new Altair chariots (most modern, horse drawn family chariot) had a PRICE elasticity of 3 and an INCOME elasticity of 2. The supply of these Altair chariots is elastic. Evaluate the following statements and explain why you think they are true, or false.
a. A 20% increase in the price of the Altair chariot will cause the quantity demanded to fall by an astounding 60%.
This statement is true. An increase in price by 20% will lead to a fall in demand by 60% as shown below
Ratio 3:2
3+2=5+2+1=8
8-2=6
6÷10×100=60%
b. An increase in Gondwanaland consumers’ incomes will cause prices to rise, but the total quantity demanded will also increase.
This statement is also true because an increase in the consumers’ incomes will increase their purchasing power. This will have a positive impact on the demand in the market hence demand rises. This excessive demand creates shortages in the market leading to an upward pressure on prices thereby leading to a rise in the price. However, since the customers’ income increase they have more disposable in their hands, therefore, they purchase more goods. This ultimately improves the desire for these goods hence increasing the total quantity of goods demanded
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References:
Baumol, W. J., " Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.
