Solution Manual for Macroeconomics for Today 9th

Edition Tucker 1305926390 9781305926394

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Chapter 6
Consumer Choice Theory

 CHAPTER IN A NUTSHELL
The rational consumer attempts to maximize total satisfaction (total utility) given their limited
income (or budget constraint). When additional units of a good or service are consumed within
any given period of time, the extra satisfaction (marginal utility) associated with each additional
unit of the good or service consumed diminishes. This is referred to as the law of diminishing
marginal utility. Consumer equilibrium is a combination of goods and services consumed which
gives the consumer the maximum total utility. This is accomplished when the marginal (extra)
utility per last dollar spent on all goods and services consumed is the same. In other words,
assuming a two goods case (goods X and Y), consumer equilibrium is defined as MUx/Px =
MUy/Py.
If the marginal utility per last dollar spent on good X is greater than the marginal utility
per last dollar spend on good Y (MUx/Px > MUy/Py), the rational consumer will consume more of
good X and less of good Y. By doing so, the consumer's total utility will increase. Moreover, as
more of X is consumed, its marginal utility will diminish. As less of good Y is consumed, the
marginal utility associated with the remaining units will be greater. Therefore, the consumer will
be moving toward an equality between the ratio of the marginal utility in relation to the price for
each good.
The theory of consumer behavior explains why the law of demand exists. If the price of
good X falls, then the rational consumer will buy more of good X because the marginal utility per
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last dollar spent will now exceed that for all other goods. Moreover, when we consider income and
substitution effects, we can more easily see why the law of demand exists.

 KEY CONCEPTS
Consumer equilibrium Substitution effect
Income effect Total utility
Law of diminishing marginal utility Utility
Marginal utility

 LEARNING OBJECTIVES
After completing this chapter, you should be able to:

1. Distinguish between total utility and marginal utility.

2. Calculate marginal utility given total utility figures associated with units of
consumption.
3. Explain the law of diminishing marginal utility.
4. Explain what is meant and what constitutes consumer equilibrium.
5. Explain under what conditions a rational consumer will consume more of one good and
less of another in order to maximize satisfaction given a limited budget.
6. Explain how the theory of consumer behavior gives rise to the law of demand.
7. Define and explain what an income and substitution effect is.
8. Explain how the income and substitution effects combined give rise to the law of
demand being observed for a normal good.

 COMPLETION QUESTIONS
1. is the satisfaction, or pleasure, that people receive from consuming
a good or service.

2. The principle that the extra satisfaction of a good or service declines as people consume
more in a given period is called the .

3. A condition in which total utility cannot increase by spending more of a given budget on
one good and spending less on another good is called .
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 4. is the change in total utility from one additional unit of a good or
service.

5. The change in quantity demanded of a good or service caused by a change in real income
(purchasing power) is called the .

6. is the amount of satisfaction received from all the units of a good or

service consumed.

7. is the change in quantity demanded of a good or service caused by

the change in its price relative to substitutes.

 MULTIPLE CHOICE
1. Total utility is measured by a mythical unit called the:
a. pleasure unit.
b. useful unit.
c. bliss unit.
d. util.

2. Assume the total utility corresponding to the first four units of a product consumed are 8,
12, 14, and 15, respectively. The marginal utility of the third unit consumed is:
a. 2.
b. 14.
c. 26.
d. 34.

3. The law of diminishing marginal utility exists for the first four units of a good if they have
marginal utilities of:
a. 4, 8, 2, 1.
b. 8, 4, 1, 2.
c. 1, 2, 4, 8.
d. 8, 4, 2, 1.

4. Consumer equilibrium is a condition in which total utility cannot increase by spending more
of a given budget on one good and spending on another good.
a. zero
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 b. more
c. less
d. an infinite amount

5. The consumer equilibrium condition for two goods is achieved by equating the:
a. marginal utilities of both goods for the last dollar spent on each good.
b. prices of both goods for the last dollar spent on each good.
c. marginal utility of one to the price of the other for the last dollar spent on each good.
d. ratios of marginal utility to the price of both goods for the last dollar spent on each good.

6. Assume a consumer purchases a combination of goods X and Y such that MUxPx = 40 units
of utility per dollar and MUyPy = 20 units of utility per dollar, to maximize utility, the
consumers should buy:
a. more of both X and Y.
b. less of both X and Y.
c. neither X nor Y.
d. more of X and less of Y.
e. less of X and more of Y.

7. The demand curve is downward-sloping because of the law of .

a. diminishing marginal utility.
b. diminishing consumer equilibrium.
c. consumer equilibrium.
d. diminishing utility maximization.

8. The income effect refers to a change in:

a. the quantity demanded of a good because of a change in the buyer's money income.
b. the quantity demanded of a good because of a change in the buyer's real income.
c. income because of changes in the CPI.
d. None of the answers above are correct.

9. Assume the price of good X increases. As a result, your real income decreases and you
decrease the quantity of good X purchased each month. This is an example of the:
a. income effect.

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 b. consumer price effect.
c. revenue effect.
d. substitution effect.
e. All of the answers above are correct.

10. Assume the price of Levi jeans increases. As a result, you decrease the quantity of Levi jeans
purchased each month and purchase more Lee jeans. This is an example of the:
a. consumption effect.
b. utility effect.
c. income effect.
d. substitution effect.

11. If water is essential for life, while diamonds are not, then why is water cheaper than
diamonds?
a. Because most people would rather die with a big diamond ring than live without one.
b. Because the total utility generated by diamonds is larger than the total utility generated
by water.
c. Because most people do not understand that they need water to live.
d. Because water is abundant, the marginal utility of water is low, and price reflects
marginal utility, not total utility.

12. When the price of a good rises, one effect of this change in price is that some consumers
switch to more affordable substitutes, which helps us understand the law of demand.
What is this effect called?
a. The marginal utility effect.
b. The substitution effect.
c. The price effect.
d. The income effect.

13. When the price of a good increases, one effect of this price increases is that consumers of
that good experience a decline in their purchasing power that is like a decline in income.
For normal goods, this contributes to the law of demand. What is this effect called?
a. The marginal utility effect.
b. The substitution effect.
c. The price effect.
d. The income effect.

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 14. Which of the following statements is true?
a. Total utility is the extra satisfaction from the consumption of a good or service.
b. Marginal utility is the amount of satisfaction received from all the units of a good or
service consumed.
c. The law of diminishing marginal utility states that as more of a good or service is
consumed total utility decreases.
d. Consumer equilibrium is a combination of goods and services consumed which
maximizes total utility from a given budget.

15. If a consumer wishes to maximize satisfaction given limited income and

MUx/Px<MUy/Py then the consumer should:
a. do nothing because she/he is in equilibrium.
b. buy more of X and less of Y.
c. buy more of Y and less of X.
d. buy more of both X and Y.
e. buy less of both X and Y.

16. Consumer equilibrium exists when:

a. the marginal utility of each good and service consumed is equal.
b. the total utility of each good and service consumed is equal.
c. the marginal utility of each good and service consumed equals its price.
d. ratio of marginal utility to price for all goods and services is equal.

17. When the price of a normal good falls, then:

a. both the income and substitution effects combine to cause the quantity demanded to
increase.
b. the substitution effect will cause people to buy more because the good is relatively less
expensive.
c. the income effect will cause people to buy more because of the increased purchasing
power associated with the lower price.
d. All of the answers above are correct.

18. The price of diamonds is higher than the price of water because:
a. diamonds give greater total utility than water.
b. diamonds are more durable than water.
c. the marginal utility for diamonds is greater than the marginal utility for water.
d. water is more scarce than diamonds.

19. Consider a consumer who spends all income on only two goods: bread and wine. An extra
loaf of bread would give the consumer 10 extra utils, while an extra bottle of wine would

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 give the consumer 60 extra utils. Bread costs 50 cents per loaf, and wine costs $6 per bottle.
In this situation, the consumer:
a. could increase utility by buying more bread and less wine.
b. could increase utility by purchasing more wine and less bread.
c. has maximized utility and attained the consumer equilibrium.
d. is violating the law of diminishing marginal utility.

20. According to the income effect, when the price of automobiles rises, people buy fewer
automobiles because:
a. they substitute other forms of transportation for driving.
b. the nominal amount of their paychecks is smaller.
c. the purchasing power of their income is reduced.
d. their demand for automobiles is very elastic.

Exhibit 1 Patty’s Day at the Amusement Park

Number of Pony Ride Zipper Hammerhead Roller Coaster

Rides MUP MUP/P MUZ MUZ/P MUH MUH/P MUR MUR/P
1 6 1.5 28 7 18 4.5 24 6
2 5 1.25 26 6.5 16 4 22 5.5
3 4 1 24 6 14 3.5 20 5
4 3 0.75 21 5.25 12 3 18 4.5
5 2 0.5 20 5 10 2.5 16 4
6 1 0.25 18 4.5 8 2 12 3
7 0.6 0.15 -8 -2 6 1.5 3 0.75
8 0.4 0.1 -30 -7.5 4 1 -35 -8.75
9 0.2 0.05 -40 -10 2 0.5 -70 -17.5

Assume that the table above describes Patty’s marginal utility for various numbers of rides at the
amusement park. The columns labeled “MU/P” refers to her marginal utility divided by the price
of each ride, which is $4.

21. Assume Patty has $24 to spend. Which of the following is her consumer equilibrium?
a. Zipper/6 rides; Roller Coaster/2 rides
b. Hammerhead/2 rides; Pony Ride/6 rides
c. Pony Ride/1 ride; Hammerhed/8 rides
d. Zipper/ 4 rides; Roller Coaster 2 rides
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 22. Assume Patty has $24 to spend and the amusement park offers a discount price of $2 per
ride for the Roller Coaster. Which of the following is her consumer equilibrium?
a. Zipper/ 3 rides; Roller Coater 6 rides
b. Pony Ride / 2 rides; Roller Coaster / 3 rides
c. Hammerhead / 5 rides; Zipper / 2 rides
d. Zipper / 6 rides; Hammerhead / 2 rides

 TRUE OR FALSE
1. T F The utility of a good measures its satisfaction rather than its usefulness.

2. T F If total utility increases from 10 to 15 for the second unit of a good

consumed, the marginal utility of the second unit is 5.

3. T F Consumer equilibrium requires that the marginal utility per dollar spent be
unequal for all goods.

4. T F The income effect is the concept that changes in consumption of a good

result from changes in government spending.
5. T F The substitution effect is the concept that changes in consumption of a good
result from changes in the relative price of a jointly consumed good.

 CROSSWORD PUZZLE

Fill in the crossword puzzle from the list of key concepts. Not all of the concepts are used.

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 ACROSS DOWN

3. Consumer is a condition in which total 1. The _____ effect is the change in

utility cannot increase by spending more of
given budget on one good and spending less
on another good.
4. ______ utility is the change in total utility
one additional unit of a good or service.
6. The change in quantity demanded of a good
or service caused by a change in real income
(purchasing power).
7. The satisfaction, or pleasure, that people
receive from consuming a good or service.
quantity demanded of a good or service a
caused by the change in its price relative
to substitutes.
2. The law of ______ marginal utility is from
the principle that the extra satisfaction
of a good or service declines as people
consume more in a given period.
5. _______ utility is the amount of
satisfaction received from all the units
of a good or service consumed.

 ANSWERS

Completion Questions

1. utility 5. income effect

2. law of diminishing marginal utility 6. total utility
3. consumer equilibrium 7. substitution effect
4. marginal utility

Multiple Choice

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1. d 2. a 3. d 4. c 5. d 6. d 7. a 8. b 9. a 10. d 11. d 12. b 13. d 14. d 15. c 16. d 17. d
18. c 19. a 20. c 21. d 22. a

True or False

1. True 2. True 3. False 4. False 5. False

Crossword Puzzle

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