Consumer Choice and Demand

12 Consumer Choice and Demand CHECKPOINTS

Checkpoint 12.1 Checkpoint 12.3 Checkpoint 12.2 Clicker version Problem 1 Problem 1 Problem 1 Problem 2 Problem 2 Problem 2 Clicker version Clicker version Problem 3 Problem 3 Problem 4 Problem 4

Practice Problem 1 Jerry’s burger and magazine budget is $12 a week. The price of a burger is $2, and the price of a magazine is $4. List the combinations of burgers and magazines that Jerry can afford. CHECKPOINT 12.1

Solution Jerry can afford the quantity of magazines (QM) and the quantity of burgers (QB) such that total expenditure equals $12. That is, $4 x QM +$2 x QB = $12 The combinations are: 3 magazines and no burgers 2 magazines and 2 burgers 1 magazine and 4 burgers no magazines and 6 burgers. CHECKPOINT 12.1

Study Plan Problem Jerry’s burger and magazine budget is $12 a week. The price of a burger is $2, and the price of a magazine is $4. Which combinations of burgers and magazines can Jerry afford? A. When Jerry buys 6 burgers a week, he cannot afford to buy a magazine. B. Jerry can afford to buy 2 burgers and 2 magazines a week. C. When Jerry spends all of his budget on magazines, he buys 3 magazines a week. D. Jerry can afford to buy 3 burgers and 3 magazines a week. E. Options A, B and C are correct. CHECKPOINT 12.1

Practice Problem 2 Jerry’s burger and magazine budget is $12 a week. The price of a burger is $2, and the price of a magazine is $4. What is the relative price of a magazine? Explain your answer. CHECKPOINT 12.1

Solution The relative price of a magazine is the number of burgers that Jerry must forgo to get 1 magazine. The relative price of a magazine equals the price of a magazine divided by the price of a burger. The price of a magazine is $2 and the price of a burger is $2, so Jerry must forgo 2 burgers to get a magazine. The relative price of a magazine equals 2 burgers. CHECKPOINT 12.1

Study Plan Problem Jerry’s burger and magazine budget is $12 a week. The price of a burger is $2, and the price of a magazine is $4. The relative price of a magazine is _______. A. $2.00 B. 0.50 magazine per burger C. 2.00 burgers per magazine D. 2.00 magazines per burger E. 0.50 burger per magazine CHECKPOINT 12.1

Practice Problem 3 Jerry’s burger and magazine budget is $12 a week. The price of a burger is $2; the price of a magazine is $4. Draw a graph of Jerry’s budget line with the quantity of magazines plotted on the x-axis. Describe how the budget line changes if, other things remaining the same, The price of a magazine falls. Jerry’s budget for burgers and magazines increases. CHECKPOINT 12.1

Solution The budget line is a straight line from 6 burgers on the y-axis to 3 magazines on the x-axis. CHECKPOINT 12.1

With a lower price of a magazine, Jerry can buy more than 3 magazines. With no change in the price of a burger, he can still buy 6 burgers. His budget line rotates outward and becomes flatter. CHECKPOINT 12.1

With a bigger budget and no change in the prices of the goods, Jerry can buy more of both goods. His budget line shifts outward. The slope of the budget line does not change because the prices do not change. CHECKPOINT 12.1

Practice Problem 4 Gas prices straining budgets As gas prices hit $3.49 a gallon, many people cut back on eating out and shopping. Some people traded in their SUV or truck for a smaller car. Source: CNN, February 29, 2008 Consider Mark who buys only two goods: gasoline and meals-to-go. As the gas price rises, describe the change in his consumption possibilities, the relative price of a meal-to-go, and Mark’s real income in terms of meals-to-go. CHECKPOINT 12.1

Solution As the price of gasoline rises, Mark’s consumption possibilities shrink. His budget line rotates inward. The relative price of a meal-to-go is the price of a meal-to-go divided by the price of gasoline. As the gas price rises, the relative price of a meal-to-go will fall. CHECKPOINT 12.1

Mark’s real income in terms of meals-to-go is the number of meals-to-go that Mark can buy. A rise in the price of gasoline does not change his real income in terms of meals-to-go. CHECKPOINT 12.1

Practice Problem 1 The table shows Jerry’s total utility from burgers and magazines. Calculate Jerry’s marginal utility per dollar from burgers when he buys 4 burgers a week. Calculate Jerry’s marginal utility per dollar from magazines when he buys 1 magazine a week. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Solution The marginal utility from the 4th burger equals the total utility from 4 burgers minus the total utility from 3 burgers, which is 38 – 32 = 6 units of utility. The marginal utility per dollar from burgers equals the marginal utility of the 4th burger, 6 units, divided by the price of a burger, $2, which is 3 units of utility per dollar. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

The marginal utility from 1 magazine equals the total utility from 1 magazine minus the total utility from no magazines, which is 100 – 0 = 100 units of utility. The marginal utility per dollar from magazines equals the marginal utility of the first magazine, 100 units, divided by the price of a magazine, $4, which is 25 units of utility per dollar. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Practice Problem 2 The table shows Jerry’s total utility from burgers and magazines. If Jerry buys 4 burgers and 1 magazine a week, does he maximize his total utility? Which good, if any, must he buy more of and which less of to maximize total utility? Explain your answer. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Solution If Jerry buys 4 burgers for $8 and 1 magazine for $4, he spends is $12 budget. His marginal utility per dollar from burgers (3) is less than his marginal utility per dollar from magazines (25), so Jerry does not maximize total utility. He must buy fewer burgers and more magazines. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Study Plan Problem If Jerry buys 4 burgers and 1 magazine a week, he ____ maximize his total utility. A. does not; Jerry can maximize his utility by buying more burgers and fewer magazines B. does C. does not; Jerry can maximize his utility by buying fewer burgers and more magazines. D. does not; Jerry can maximize his utility by spending all of his income on burgers or by spending all of his income on magazines CHECKPOINT 12.2 • Jerry’s total utility from burgers and magazines. • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Practice Problem 3 The table shows Jerry’s total utility from burgers and magazines. What quantities of burgers and magazines in a week maximize Jerry’s utility? CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Solution Jerry maximizes utility if he buys 2 burgers and 2 magazines a week. He spends $4 on burgers and $8 on magazines, which equals his $12 budget. His marginal utility for burgers is 24 – 14 = 10 units. Dividing 10 units by $2 gives 5 units of utility per dollar. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

His marginal utility for magazines is 120 – 100 = 20 units. Dividing 20 units by $4 gives 5 units of utility per dollar. Jerry’s marginal utility per dollar is 5 units per dollar for both goods and utility is maximized. CHECKPOINT 12.2 • The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 to spend.

Practice Problem 4 When will food prices stop rising? No time soon Food prices have risen almost 5 percent during the past year, the highest annual increase in almost 20 years. Source: USA Today, June 8, 2008 How will the rise in the price of food change the budget line and the quantity of food that Americans buy? CHECKPOINT 12.2

Solution The budget line rotates inward. Consumers allocate their budget between food (F) and non-food (N) items such that (MUF/PF) = (MUN/PN). As the price of food rises, (MUF/PF) falls. So with (MUF/PF) < (MUN/PN), consumers will reallocate their income to make (MUF/PF) rise and equal (MUN/PN). To make ((MUF/PF) rise, the quantity of food bought must decrease. CHECKPOINT 12.2

Practice Problem 1 In a year, Tony rents 500 DVDs at $3 each and pays $50 for 10,000 gallons of tap water. Tony is maximizing total utility. If Tony’s marginal utility from water is 0.5 units per gallon, what is his marginal utility from a DVD rental? Which good is the more valuable to Tony: water or DVDs? Why? CHECKPOINT 12.3

Solution Because Tony is maximizing his total utility: Marginal utility of a DVD rental ÷ $3 = Marginal utility of a gallon of water ÷ 0.5¢. Marginal utility of a DVD rental = 600 x Marginal utility of a gallon of water. Marginal utility of a DVD rental = 600 x 0.5 = 300 units. Most likely, the total utility from water is larger, so Tony values water more than he values DVDs. CHECKPOINT 12.3

Practice Problem 2 Over the years, Americans have spent a smaller percentage of income on food and a larger percentage on cars. Explain the paradox of value. CHECKPOINT 12.3

Solution The average person has one car and the marginal utility from driving the car exceeds the marginal utility from food. While food is cheap and cars are expensive, consumers allocate their income to make the marginal utility per dollar equal for food and cars. There is no paradox of value. CHECKPOINT 12.3

Consumer Choice and Demand