Consumer Behaviour

Managerial Economics Tutorial-2

1. The total utility coincides with the marginal utility

a) for the first unit consumed.
b) only for the irrational consumer.
c) at the level of the last unit consumed.
d) at the saturation point.

2. All points on or below a budget constraint

a) are attainable with the given income.
b) are equally desirable.
c) represent market basket combinations that exhaust the income available.
d) are described, in part, by a, b, and c above.

3. The graph below indicates that the consumer

a) at A is indifferent between a pounds of apples and b pounds of butter.

b) at A is consuming either a pounds of apples or b pounds of butter.
c) is indifferent between a pounds of apples plus b pounds of butter on the one hand and
c pounds of apples plus d pounds of butter on the other.
d) is correctly described by all the above.

4. This graph also indicates that the consumer prefers combination

a) A to B
b) C to B
c) B to D
d) E to F
5. As long as all prices remain constant, an increase in money income results in
a) an increase in the slope of the budget line.
b) a decrease in the slope of the budget line.
c) an increase in the intercept of the budget line.
d) a decrease in the intercept of the budget line.
e) both (a) and (c).

6. If a man prefers Pepsi to Fanta and Fanta to Frooti, and if he is indifferent between Pepsi
and Coca Cola, he must
a) prefer Fanta to Coca Cola.
b) prefer Coca Cola to Frooti.
c) be indifferent between Pepsi and Frooti.
d) be indifferent between Frooti and Coca Cola.

7. If a good is normal, then the demand curve and Engel curve for that good must be
(respectively)
a) downward sloping; downward sloping.
b) upward sloping; downward sloping.
c) downward sloping; upward sloping.
d) upward sloping; upward sloping.

8. Which of the following assumptions is (are) NOT made in consumer behaviour

theory?
a) Consumers can rank all bundles of goods.
b) Consumers have complete information.
c) Consumers can measure the utility they get from all bundles of goods.
d) both b and c
e) None of the above are assumptions made in consumer behaviour theory.

9. Dennis, who consumes only grilled chicken sandwiches and salads with low-fat
dressing, has a weekly income of $100. He is currently consuming 20 grilled chicken
sandwiches per week, at a price of $3 each, and 20 salads per week, at a price of $2
each. If the last sandwich and the last salad both added 40 units to Dennis's total
utility, he
a) is making the utility-maximizing choice.
b) should buy more salads and fewer sandwiches.
c) should buy more sandwiches and fewer salads.
d) obtains more additional utility per dollar from sandwiches than from salads.

10. The rate at which a consumer is WILLING to substitute one good for another is
measured by the
a) slope of the tangent to the indifference curve.
b) slope of the budget line
c) indifference map
 d) consumer’s real income

11. Draw indifference curves that represent the following individuals’ preferences for
hamburgers and soft drinks.

a) Joe has convex preferences and dislikes both hamburgers and soft drinks.
Since Joe dislikes both goods, he prefers less to more, and his satisfaction is increasing in
the direction of the origin. Convexity of preferences implies his indifference curves will
have the normal shape in that they are bowed towards the direction of increasing
satisfaction. This is true of the indifference curves shown in the diagram below.

b) Bob loves hamburgers and dislikes soft drinks. If he is served a soft drink, he will
drink it to be polite.

Since Bob will drink the soft drink in order to be polite, it can be thought of as a “bad.”
More hamburgers and fewer soft drinks will increase his utility, so his satisfaction
increases as we move upward and to the left.

c) Molly loves hamburgers and soft drinks but insists on consuming exactly one soft
drink for every two hamburgers that she eats.
 Molly wants to consume the two goods in a fixed proportion so her indifference curves
are L-shaped. For a fixed amount of one good, she gets no extra satisfaction from having
more of the other good. She will only increase her satisfaction if she has more of both
goods.

d) Rita likes both hamburgers and soft drinks, but beyond 6 bottles of soft drinks,
soft drinks become a bad commodity and beyond 4 pieces of hamburgers,
hamburgers become a bad commodity.

Circular Indifference Curve (as done in the tutorial)

e) Mary always gets twice as much satisfaction from an extra hamburger as she
does from an extra soft drink.

How much extra satisfaction Mary gains from an extra hamburger or soft drink tells us
something about the marginal utilities of the two goods and about her MRS. If she always
receives twice the satisfaction from an extra hamburger then her marginal utility from
consuming an extra hamburger is twice her marginal utility from consuming an extra soft
drink. Her MRS, with hamburgers on the vertical axis, is 1/2 because she will give up one
hamburger only if she receives two soft drinks. Her indifference curves are straight lines
with a slope of 1/2.

12. Anne has a job that requires her to travel three out of every four weeks. She has an
annual travel budget M and can travel either by train or by plane. The initial price of
tickets for train and plane is Pt and Pa respectively. (notations are given in terms of
price per mile). The airline on which she typically flies has a frequent-traveler
 program that reduces the cost of her tickets according to the number of miles she
has flown in a given year. When she reaches 25,000 miles, the airline will reduce the
price of her tickets by 25% for the remainder of the year. When she reaches 50,000
miles, the airline will reduce the price by 50% for the remainder of the year. Graph
Anne’s budget line, with train miles on the vertical axis and plane miles on the
horizontal axis.

Kinked budget line (as done in the tutorial)

Y intercepts: M/Pt , (M-25000Pa)/Pt & (M-25000Pa-25000*0.75Pa)/Pt
X intercepts: 25000 , 50000 & M/(0.5Pa)

13. Jane receives utility from days spent traveling on vacation domestically (D) and days
spent traveling on vacation in a foreign country (F), as given by the utility function
U(D,F)=10DF. In addition, the price of a day spent traveling domestically is $100, the
price of a day spent traveling in a foreign country is $400, and Jane’s annual travel
budget is $4000.
a) Illustrate the indifference curve associated with a utility of 800 and the
indifference curve associated with a utility of 1200.

The indifference curve with a utility of 800 has the equation 10DF =800. Find
combinations of D and F that satisfy this equation and plot the indifference curve. The
indifference curve with a utility of 1200 has the equation 10DF =1200. Find
combinations of D and F that satisfy this equation and plot the indifference curve
b) Graph Jane’s budget line on the same graph.

If Jane spends all of her budget on domestic travel she can afford 40 days. If she spends
all of her budget on foreign travel she can afford 10 days. Her budget line is 100D +400F
=4000. This straight line is plotted in the graph.
 c) Can Jane afford any of the bundles that give her a utility of 1200?

Jane can afford some of the bundles that give her a utility of 800 because part of the U
=800 indifference curve lies below the budget line. She cannot afford any of the bundles
that give her a utility of 1200 as this indifference curve lies entirely above the budget line.
d) Find Jane’s utility maximizing choice of days spent traveling domestically and
days spent in a foreign country.

The optimal solution is F =5 and D =20. Utility is 1000 at the optimal bundle, which is on
an indifference curve between the two drawn in the graph above.
14. A consumer has the utility function over goods X and Y, given by U(X, Y) = 12X² Y³.
Let the price of good X be given by Px, let the price of good y be given by Py, and let
income be given by M. What is the slope of the consumer’s indifference curve at the
consumption bundle, (1,1)?
2
The slope of the Indifference Curve is: (- )
3

15. Assume that there are two goods. The price of the first good is $10 and the price of
the second good is $20. The income is m=200.
 a) Determine the budget constraint.

Budget Constraint: 10X+20Y=200

b) Assume that income increases to m=300. At the same time the price of good 1
increases to 20. Determine the equation of the new budget line.

New Budget Equation: 20X+20Y=300

c) Determine the slope and the intercepts of the new budget line. Graph the new
budget set.

Slope of the new budget line: -1

X intercept: 15
Y intercept: 15

16. Donald Fribble’s utility function is given as follows: U(s,t)=s+ln t, where s is the
number of stamps he collects and t is the number of twinkies he consumes. The
price of stamps is Ps and the price of twinkies is Pt. Donald’s income is M.
a) Write an expression that says that the ratio of Donald’s MU for twinkies to his
MU for stamps is equal to the ratio of the price of twinkies to the price of
stamps.
Pt/Ps=1/t

b) Choose the equation you found in the last part to show that if he buys both
goods, Donald’s demand function for twinkies depends only on the price ratio
and not on his income.
t=Ps/Pt

c) Find the total amount of money that Donald spends on twinkies if he buys both
goods.
Total budget on twinkies=Ps

d) Use the budget equation and Donald’s demand function for twinkies to find an
expression for the number of stamps he will buy.
(M/Ps)-1=s
e) If M<Ps, what would Donald’s demand for postage stamps be? What would his
demand for twinkies be?
 Demand for postage stamps: s=0
Demand for twinkies: t=M/Pt (Boundary Optimum)

17. Suppose that we consider the daily market for ice-cream sandwiches in the
neighbourhoods surrounding IIMB as follows:
Supply: Q = 500(P - 2) & Demand: Q = 11000 - 1000P
What is the consumer surplus?
Find the equilibrium price and quantity from the Demand and Supply equations.
P=8 and Q=3000
At Q=0, P=11
Consumer Surplus= 4500

18. Suppose the market for watermelons can be described by the graph below.

a) How much total consumer surplus is received in this market?

Consumer Surplus=500