Chapter 5/Consumer Choice: Individual and Market Demand

CHAPTER 5
CONSUMER CHOICE:
INDIVIDUAL AND MARKET DEMAND
TEST YOURSELF
1. Which gives you greater total utility: 14 gallons of water per day or 22 gallons per day?
Why?
The total utility from 22 gallons is greater, since it is equal to the total utility (or
usefulness) of the first 14 gallons, plus the total utility of the next 8.
2. At which level do you get greater marginal utility: 14 gallons per day or 22 gallons per
day? Why?
The marginal utility at 12 gallons is greater. You use the first 12 gallons for your
highest priorities. The next gallons are used for purposes of decreasing importance. This
is the “law” of diminishing marginal utility.
3. Emily buys an air conditioner that costs $700. Because the air in her home is cleaner, its
use saves her $250 in curtain cleaning costs over the lifetime of the air conditioner. In
money terms, what is the opportunity cost of the air conditioner?
Since the $700air conditioner saves Emily $250 in cleaning costs, the opportunity
cost of the air conditioner is only $450.
4. Suppose that strawberries sell for $3 per basket. Jim is considering whether to buy
zero, one, two, three, or four baskets. On your own, create a plausible set of total
and marginal utility numbers for the different quantities of strawberries (as we did
for pizza in Table 1), and arrange them in a table. From your table, calculate how
many baskets Jim would buy.
Baskets Marginal Utility ($) Total Utility ($)
0 — —
1 6 6
2 4 10
3 3 13
4 1 14
At a price of $3 per basket Jim will buy 3 baskets.
5. Draw a graph showing the consumer’s surplus Jim would get from his strawberry
purchase in Test Yourself Question 5, and check your answer with the help of your
marginal utility table.
Figure 1 shows that Jim buys 3 boxes of berries, where marginal utility equals
price. On the first box, his consumer’s surplus is the excess of MU (6) above P (2), or the
dotted line AB. Similarly his surplus on the second box is CD (4 - 2), and the total
consumer’s surplus is the sum of the two lines, 4 + 2, or 6.

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 Chapter 5/Consumer Choice: Individual and Market Demand

FIGURE 1

6. Consider a market with two consumers, Jasmine and Jim. Draw a demand curve for
each of the two consumers, and use those curves to construct the demand curve for the
entire market.

FIGURE 2

DISCUSSION QUESTIONS
1. Describe some of the different ways you use water. Which would you give up if the price
of water were to rise a little? If it were to rise by a fairly large amount? If it were to rise
by a very large amount?
In descending order of importance, water is used for drinking, for cooking, for
bathing, to feed pets, to wash clothes, to water lawns, to store in swimming pools, etc.
(the students’ order may differ). As the price of water rose, you might give up some of
these uses, beginning at the end of the list. Alternatively, you might retain all or most of
these uses, but cut down on the amount for each.
2. Suppose that you wanted to measure the marginal utility of a commodity to a consumer
by directly determining the consumer’s psychological attitude or strength of feeling
toward the commodity rather than by seeing how much money the consumer would
give up for the commodity. Why would you find it difficult to make such a
psychological measurement?

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school approved
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 Chapter 5/Consumer Choice: Individual and Market Demand

You could ask the consumer to construct a scale, from 1 to 100, then reveal where
on the scale each commodity falls. Or you could try measuring blood pressure or pulse as
the consumer gets different commodities. But there is no guarantee that either procedure
would be meaningful. The self-constructed scale might be biased and inconsistent; the
consumer’s physiological response might have little to do with satisfaction. There are
some obvious (and not so obvious) objections to using the amount of money a person is
willing to give up as a measure of utility, but there does not seem to be a better solution.
3. Some people who do not understand the optimal purchase rule argue that if a consumer
buys so much of a good that its price equals its marginal utility, the consumer could not
possibly be behaving optimally. Rather, they say, the consumer would be better off
quitting while ahead or buying a quantity such that marginal utility is much greater
than price. What is wrong with this argument? (Hint: What opportunity would the
consumer then miss? Is it maximization of marginal or total utility that serves the
consumer’s interests?)
It is reasonable to assume that rational consumers are trying to get the most
possible consumer’s surplus for themselves, that is, the most total utility less expenditure
—not the most possible average utility per good or marginal utility. If a consumer quit
buying when the marginal utility was higher than the price, then he or she would be
forgoing the opportunity to increase consumer’s surplus: By buying one more unit, the
consumer could accumulate more utility than he or she would be giving up in terms of
money forgone. This will continue to be true until so much is bought that the marginal
utility of the next good has fallen to a level equal to the price.
4. You have $20,000 to invest in the stock market, which has been rising rapidly for the
past 18 months. What course of action seems rational?
Perhaps you should invest in the stock market now on the expectation that stock
prices will continue to rise. On the other hand, if you expect prices to fall then you would
want to wait to purchase stock.

ANSWERS TO APPENDIX QUESTIONS

TEST YOURSELF
1. John Q. Public spends all of his income on tacos and hot dogs. Draw his budget line
under several conditions:
a. His income is $100, and one taco and one hot dog each cost $2.
b. His income is $150, and the two prices remain the same.
c. His income is $100, hot dogs cost $2 each, and tacos cost $2.50 each.
FIGURE 3

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school approved
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 Chapter 5/Consumer Choice: Individual and Market Demand

2. Draw some hypothetical indifference curves for John Q. Public on a diagram identical
to the one you constructed for Test Yourself Question 1.
a. Approximately how many tacos and how many hot dogs will Mr. Public buy?
b. How will these choices change if his income increases to $150? Is either good an
inferior good?
c. How will these choices change if the price of a taco rises to $3.00?

FIGURE 4

(a) 25 tacos and 25 hot dogs.

(b) approximately 37.5 tacos and 37.5 hot dogs; Since the consumption of
both goods increased when his income increased, both goods are normal goods which
means that neither is an inferior good.
(c) approximately 16 tacos and 26 hot dogs

3. Explain the information that the slope of an indifference curve conveys about a
consumer’s preferences. Use this relationship to explain the typical U-shaped
curvature of indifference curves.
The slope of an indifference curve is the maximum number of units of the good
on the Y-axis (say, cookies) the consumer is willing to give up to get one more unit of the
good on the X-axis (say, compact discs). An indifference curve that is U-shaped with
respect to the origin has a relatively large slope towards the upper left side and a
relatively small slope towards the lower right. This indicates that a consumer who has
many cookies but few compact discs is willing to give up a lot of cookies in order to get
one more compact disc—but when the tables are turned, the consumer who has many
compact discs and only a few cookies is willing to give up only a small number of
cookies to get an additional compact disc. This is consistent with the idea of diminishing
marginal utility in the case of one good considered alone.

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school approved
learning management system for classroom use.