ECON1001

1. ECON1001 Tutorial 5

2. Q1. When P=$15, what is the consumer surplus each day? • $40 • $75 • $105 • $180 • $0 Ans: b

3. P/($ unit) • First of all, how many units are traded when P=$15? • The person will continue buying until the amount he is willing to pay for the last unit is the same as the price • Therefore, this person is buying 6 units of the good each day. 15 6 Q (Units/day)

4. Consumer Surplus • How is consumer surplus calculated? • Consumer surplus is the difference between the amount of money a person is willing to spend on a unit of good and the actual price of that unit (MU – P). • Adding up all the Consumer Surplus from each unit and we can obtain the total Consumer Surplus each day.

5. P/($ unit) • The CS of the 1st unit is $40 - $15. • The CS of the 2nd unit is $35 - $15. • So on and so forth. • The CS is the total area sandwiched between the MU schedule and price. 40 35 30 25 20 15 1 2 3 4 5 6 Q (Units/day)

6. CS = (40 – 15) + (35 – 15) + (30 – 15) + (25 – 15) + (20 – 15) + (15 – 15) = (40 + 35 + 30 + 25 + 20 + 15) – (15 ∙6) = $75

7. Q2. When price is $0.75, how many cans of soda will be demanded according to the market demand curve? • 20 • 50 • 70 • 100 • 130 Ans: b

8. Total quantity demanded by the market is the sum of Mallory’s Qd and Rick’s Qd when price is $0.75. • Mallory’s Qd is ? when price is $0.75. • Rick’s Qd is ? when price is $0.75. • Therefore, the total quantity demanded is 30+20 = 50 (B). 30 20

9. Q3.After prices of beans have been reduced, consumption of beans falls. Why? • The Sub Effect caused people to substitute noodles and rice for beans. • The Income Effect caused people’s real income to fall, so they could no longer afford as much food. • The Income Effect caused people’s real income to rise so they purchased less of what they considered to be inferior goods. • Demand for beans is price inelastic. • The only possible explanation is that people chose irrationally. Ans: c

10. (D) is obviously wrong because even if demand is price inelastic, Qd would still ↑ when P ↓ -- law of demand!! At the extreme situation that demand is perfectly price inelastic, Qd will be unchanged when P ↓. • In economics, it is a very basic assumption that all people choose rationally. Hence, (E) is also not the correct answer.

11. (A) is logically wrong. • Holding real income constant… • Substitution effect is always driving Qd up when P drops. Beans have become cheaper, and hence, people will have more of beans and giving up some of the other goods.

12. (B) and (C) are both about income effect. • (B) says Real Income ↓ so Qd ↓. • Wrong! Price of a good drops, even though the money income of people has not changed, their Real Income has increased because of the increase in purchasing power.

13. Now, we know that Sub Effect must have raised Qd for beans. • Nevertheless, the final outcome of the price cut is a reduction in consumption of beans. That must mean Income Effect has driven down Qd by much. • Plus, we know that Real Income increases. As a result, we can conclude that beans are inferior goods (negative Income Effect)

14. Q4. Given Jessy’s MU of watching movies and eating out each month, Find the optimal combination of the two if she spends $100 every month on these, PM=$10, PD=$20. • 4 movies, 3 dinners • 2 movies, 4 dinners • 6 movies, 2 dinners • 4 movies, 0 dinners • 0 movies, 8 dinners Ans: b

15. A bundle is optimal when the Rational Spending Rule is followed. MU per dollar is the same for each good - • This is the same as MRS = PM/PD. • Calculate MU/P for each unit of Movie and Dinner, then find the optimal bundle by matching the ratios.

16. If we have only $20 to spend, we will spend all $20 on dinner because first dinner yields the highest MU/$. If we have only $40 to spend, we will spend all $40 on dinner because second dinner yields a higher MU/$ than movie. If we have only $70 to spend, we will spend $60 on dinner and $10 on movie. Now the MU/$ is the same for the two activities. If we have only $100 to spend, we will spend $80 on dinner and $20 on movie. Now the MU/$ is the same for the two activities.

17. Jessy will choose to go to 2 movies and 4 dinners, because at these quantities,

18. Q5. Patel applies the Rational Spending Rule and purchases 10 units of M and 6 units of N. Suppose the price of N decreases. Patel will… • Cease purchasing N. • ↓ QN and ↑ QM. • Same QN and QM. • ↓ QM. • ↑ QN and ↓ QM. Ans: e

19. Unless Good N is a Giffen Good, when PN drops, more of Good N will be bought (as a result of both Sub and Inc Effects) • (E) is the only option mentioning an increase in consumption of Good N, and so, it is the correct answer. • Note that if we are allocating a fixed income between two goods, the rational spending rule says we should allocate more spending to good M and less on good N if MUM/PM > MUN/PN. We are at equilibrium (utility maximized) when MUM/PM = MUN/PN • Suppose we were initially allocating our income so that MUM/PM = MUN/PN. A decrease in PN will lead to MUM/PM < MUN/PN. Then, more income should be spent on good N and less on good M.

20. Q6. Josh can spend money on playing pool and bowling. MUP = 10 after 5 games. MUB = 6 after 3 games. Both pool and bowling cost $1 a game. To maximise his utility, Josh should… • Bowl more and play pool less. • Bowl only. • Bowl less and play pool more. • Just go home. • Do both for the same amount of times. Ans: c

21. If Josh chooses one activity, he is forgoing the utility from the other activity. • (D) makes no sense as Josh would be choosing to forgo any chance of raising his utility. • (A + B) means Josh is giving up (some of) his chance of taking part in pool, a game that gives him higher utility than bowling at the margin. Hence they are not the correct answers.

22. (E) is also not ideal because if he plays more pool, his utility can be increased by much more. • (C) is the sensible choice. Josh can still play both games, but the number of times playing differs. Since playing pool is a more ‘satisfactory’ activity, playing more of it will raise Josh’s utility by much compared to bowling. • Note that 10=MUP/PP > MUB/PB=6. Thus, Josh should switch his spending from B to P.

23. Q7) Anna earns $150 per week. She consumes fish ($3/pound) and shrimp ($5/pound). Anna can therefore buy a maximum of ? pounds of fish or a maximum of ? Pounds of shrimp. • 30; 50 • 50; 30 • 15; 30 • 30; 15 • 50; 15 Ans: B

24. By using the division function of any reliable calculator, finding the answer to this question would not be too difficult. • If Anna only buys fish, she will be spending all $150 on fish, which costs $3/pound. • Therefore, at maximum, Anna can buy 50 pounds of fish.

25. And if Anna chooses to buy shrimp only, she will spend all her budget on shrimp. • $150 in the pocket, and the price of shrimp is $5 a pound. • 150 5 • Anna can buy 30 pounds of shrimp at maximum, should she chooses not to buy any fish.

26. Hence, the answer is (B) – 50 pounds of fish or 30 pounds of shrimp.

27. Q8. According to the Law of Diminishing Marginal Utility, • If you consume less of something, your total utility from that consumption increases. • If you consume more of something, the next unit you consume will deliver more utility than did the last unit you consumed. • You should never consume any more of something after marginal utility has begun to diminish. • If total utility is increasing as you consume more, then marginal utility must be increasing as well. • Marginal utility tends to decrease when you consume more of the same item. Ans: e (by definition)

28. Q9.If MU is positive as consumption increases, • The consumer will not experience diminishing MU. • Total utility will remain high and constant as consumption increases. • Total utility will increase as consumption increases. • The demand curve will necessarily have a positive slope. • The demand curve will be a horizontal line. Ans: c

29. According to the Law of Diminishing MU, MU of the last unit will decrease as more units are consumed, holding other factors constant. • However, that does not mean Total Utility will drop. • MU can still be positive as it diminishes. • As long as MU is positive, ↑ Q will ↑ TU.

30. (A) is not true. No special assumptions on MU mentioned, so the usual Law of Dim MU assumption still holds. • (B) is wrong as well. TU will not remain constant as we know that consumption of additional units brings positive MU (hence raising TU). • (D) is incorrect. We certainly are not assuming increasing MU. • (E) is implicitly assuming MU staying constant. As there is any special postulates made about MU, (E) is not the correct answer.

31. (C) is the correct answer. • The satisfaction from each additional unit may come in a lower lever as consumption continues, nevertheless, more utility is generated. • Total utility will always increase when MU is positive.

32. Q10. In some countries, medical care is provided free to citizens and paid for by the government. In those countries, medical care is… • Not a scarce resource. • Available at zero opportunity cost. • Rationed by monetary prices. • Rationed by non-monetary costs. • Available at no cost to everyone who wants it. Ans: d

33. (A) is obviously a wrong answer. Medical care is not only a scarce resource, it is also very expensive. • (B) and (E) are also not true. Just because medical care is provided to users in those countries free of charge, it does not mean the service is costless. The question also states that it is the government who pays for the health service in those countries. • (C) is incorrect as the question mentions that medical care is free to citizens.

34. Free medical service means the price of health care is 0. • As we have established that medical care is scarce, Qd > Qs when P = 0. There must be excess demand for it. • As price is fixed at 0, the only thing that can happen to meet the demand for medical care is by non-monetary means. • Some examples are long waiting lists and quotas. • Therefore, the answer is (C). • The implication is that the low income family are more likely to use the public health system. (Because their time cost is lower, they are more willing to wait in line for hours to see a doctor.) Note that the waiting time could be spent on some more productive activities or leisure. Thus, the waiting time can be viewed as a waste to the society.