Microeconomics Canada in the Global

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 C h a p t e r
8 UTILITY AND
DEMAND

Answers to the Review Quizzes

Page 180
1. Explain how a consumer’s income and the prices of goods limit consumption
possibilities.
A consumer’s consumption possibilities are limited by the consumer’s income and the prices
of the goods. The consumer is unable to consume limitless quantities of goods and services
because the consumer must pay a price for each good or service consumed and the
consumer’s income is limited.
2. What is utility and how do we use the concept of utility to describe a consumer’s
preferences?
Utility is the benefit or satisfaction a person gets from the consumption of goods and
services. We use total utility to describe a consumer’s preferences by looking at the total utility
from the consumption of all the goods and services. We use marginal utility to measure the gain
in utility from consuming another unit of a good or service.
3. What is the distinction between total utility and marginal utility?
Total utility is the total benefit that a person gets from the consumption of all the different
goods and services. Marginal utility is the change in total utility from a one-unit increase in
the quantity of a good consumed.
4. What is the key assumption about marginal utility?
The key assumption about marginal utility is the tendency for marginal utility to decrease as
the consumption of a good increases. This tendency is so general and universal that we refer
to it as the principle of diminishing marginal utility.
Page 184
1. Why does a consumer spend the entire budget?
The more goods and services a person consumes, the higher the person’s utility. By
spending her entire budget, a person is consuming the maximum possible quantity of goods
and services, which means the utility can be at its maximum.
2. What is the marginal utility per dollar and how is it calculated?
The marginal utility per dollar equals the marginal utility of the good or service divided by its
price. The marginal utility per dollar tells the additional utility gained from spending one more
dollar on a good or service.
3. What two conditions are met when a consumer is maximizing utility?
The two conditions that are met when a consumer is maximizing utility are: i) all available
income is spent, and ii) the marginal utility per dollar is equal for all goods.

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108 CHAPTER 8

4. Explain why equalizing the marginal utility per dollar for all goods maximizes
utility.
Equating the ratio of marginal utility per dollar for each good and service consumed
maximizes utility because it measures the utility gained when an additional dollar of a good or
service is consumed. This allows the consumer to weigh the utility gained from additional
consumption of a dollar’s worth of one good against the utility lost from the forgone
consumption of a dollar’s worth of another good. When the marginal utility per dollar for each
good and service is equalized, there is no additional utility available from any other
consumption combination.
Page 190
1. When the price of a good falls and the prices of other goods and a consumer’s
income remain the same, explain what happens to the consumption of the good
whose price has fallen and to the consumption of other goods.
When the price of a good falls, the marginal utility per dollar for that good increases. The
marginal utility per dollar for other goods does not change. To maximize total utility, a
consumer makes marginal utility per dollar equal for all goods, so the consumer buys more of
the good that has experienced the fall in price and less of the goods whose marginal utilities
per dollar have not changed.
2. Elaborate on your answer to the previous question by using demand curves. For
which good does demand change and for which good does the quantity
demanded change?
After the price of a good falls, the consumer increases consumption of the good to lower the
marginal utility per dollar. More of the good is consumed at the lower price, which implies that
the demand curve for the good is downward sloping. The consumer increases the quantity
demanded of this good. The consumer decreases the quantity of the other goods and
services consumed although the price of other goods and services remain unchanged. The
demand curves for each of the other goods and services shift leftward.
3. If a consumer’s income increases and if all goods are normal goods, explain how
the quantity bought of each good changes.
If a consumer’s income increases and all the goods consumed are normal goods, then the
consumption of all goods increases. The initial consumption bundle does not require the
consumer to spend all of his income. If the consumer’s total utility for all goods increases with
consumption, he will use the money remaining to increase the quantity consumed of all
goods and services. This increase occurs while the price of these goods and services
remains unchanged, so there is a rightward shift of the demand curve for all goods and
services.
4. What is the paradox of value and how is the paradox resolved?
The paradox of value asks: “Why is water, which is essential to life, far cheaper than
diamonds, which are not essential?” Consumers have diminishing marginal utility for water.
The marginal utility of the last unit of water consumed is low because water is readily
available and so the quantity consumed is very high. Consumers also have diminishing
marginal utility for diamonds. The marginal utility of the last diamond consumed is high
because diamonds are very scarce and so the quantity consumed is very low. Consumers
maximize utility by equating the marginal utility per dollar for both goods. The scarcity of
diamonds (high marginal utility) and the abundance of water (low marginal utility) indicate
people are willing to pay a higher price for an additional unit of diamonds than for an
additional unit of water.

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 UTILITY AND DEMAND 109

5. What are the similarities between utility and temperature?

The scales of both utility and temperature are arbitrary. The units used to measure both can
be changed without changing their predictive abilities. For instance, the scale used to
“measure” utility can be changed without consequence and the scale used to measure
temperature (such as Celsius, Fahrenheit, or Kelvin) also can be changed without
consequence. Additionally, although neither utility nor temperature can be directly observed,
both can be used to make predictions about the observable world.
Page 193
1. Define behavioural economics.
Behavioural economics studies the ways in which limits on the human brain’s ability to
compute and implement rational decisions influences economic behaviour—both the
decisions that people make and the consequences of those decisions for the way markets
work.
2. What are the three limitations on human rationality that behavioural economics
emphasizes?
The three limitations on human rationality that behavioural economics emphasizes are
bounded rationality (the rationality that is limited by the computing power of the human brain),
bounded willpower (the less-than-perfect willpower that prevents us from making a decision
that we know, at the time of implementing the decision, we will later regret), and bounded
self-interest (the limited self-interest that results in sometimes suppressing our own interests
to help others).
3. Define neuroeconomics.
Neuroeconomics studies the activity of the human brain when it makes an economic
decision.
4. What do behavioural economics and neuroeconomics seek to achieve?
Behavioural economics and neuroeconomics seek to explain why we do not always make
rational economic decisions. Behavioural economists study how the bounded limitations they
study affect people’s decisions so that not all decisions are the consequence of rational
behaviour. Neuroeconomists study how the brain works to make decisions so that
neuroeconomists have a better understanding of the decisions people make.

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110 CHAPTER 8

Answers to the Study Plan Problems and Applications

Jerry has $12 a week to spend on yogurt and berries. The price of yogurt is $2, and
berries are $4 a box.
1. List the combinations of yogurt and berries that Jerry can afford. Draw a graph of
Jerry’s budget line with the quantity of berries plotted on the x-axis.
Jerry can buy 6 yogurts and 0 boxes of
berries; 4 yogurts and 1 box of berries; 2
yogurts and 2 boxes of berries; and, 0
yogurts and 3 boxes of berries. Figure 8.1
shows Jerry’s budget line.
2. How do Jerry’s consumption possibilities
change if, other things remaining the
same, (i) the price of berries falls and (ii)
Jerry’s income increases.
(i) If the price of a box of berries falls, Jerry’s
consumption possibilities increase. His
budget line rotates outward around the
unchanged vertical intercept, which shows
the (unchanged) maximum quantity of yogurt
Jerry can buy.
(ii) If Jerry’s income increases, Jerry’s
consumption possibilities increase. His
budget line shifts outward and its slope does
not change.

Use the following data to work Problems 3 to 8.

Max has $35 a day to spend on windsurfing
Total utility Total utility
and snorkelling and he can spend as much
Hours from from
time as he likes doing them. The price of per day windsurfing snorkelling
renting equipment for windsurfing is $10 an
1 120 40
hour and for snorkelling is $5 an hour. The 2 220 76
table shows the total utility Max gets from 3 300 106
each activity. 4 360 128
3. Calculate Max’s marginal utility from 5 396 140
windsurfing at each number of hours 6 412 150
per day. Does Max’s marginal utility 7 422 158
from windsurfing obey the principle of
diminishing marginal utility?
Max’s marginal utility from the first hour windsurfing per day is 120; from the second hour per
day is 100; from the third hour per day is 80; from the fourth hour per day is 60; from the fifth
hour per day is 36; from the sixth hour per day is 16; and from the seventh hour per day is
10. Max’s marginal utility from windsurfing obeys the principle of diminishing marginal utility
because his marginal utility decreases as consumption increases.

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 UTILITY AND DEMAND 111

4. Calculate Max’s marginal utility from snorkelling at each number of hours per day.
Does Max’s marginal utility from snorkelling obey the principle of diminishing
marginal utility?
Max’s marginal utility from the first hour snorkelling per day is 40; from the second hour per
day is 36; from the third hour per day is 30; from the fourth hour per day is 22; from the fifth
hour per day is 12; from the sixth hour per day is 10; and from the seventh hour per day is 8.
Max’s marginal utility from snorkelling obeys the principle of diminishing marginal utility
because his marginal utility decreases as consumption increases.
5. Which does Max enjoy more: his 6th hour of windsurfing or his 6th hour of
snorkelling?
Max’s marginal utility from his 6th hour of windsurfing is 16 and his marginal utility from his
6th hour of snorkelling is 10. Max enjoys his 6th hour of windsurfing more than his 6th hour of
snorkelling.
6. Make a table of the combinations of hours spent windsurfing and snorkelling that
Max can afford.
The table is to the right. The Marginal Marginal
first and third columns show utility per utility per
the combinations of Hours dollar from Hours dollar from
windsurfing and snorkelling windsurfing windsurfing snorkelling snorkelling
Max can afford. 3 8.0 1 8.0
7. Add two columns to your 2 10.0 3 6.0
1 12.0 5 2.4
table in Problem 6 and list
0 7 1.6
Max’s marginal utility per
dollar from windsurfing and from snorkelling.
The columns are in the table, in the second and fourth columns.
8. a. To maximize his utility, how many hours a day does Max spend on each
activity?
To maximize his utility, Max windsurfs for 3 hours and snorkels for 1 hour.
Max uses his $35 so that all of the $35 is spent and so that the marginal utility per dollar from
each activity is the same. When Max windsurfs for 3 hours and snorkels for 1 hour, he
spends $30 renting the windsurfing equipment and $5 renting the snorkelling equipment—a
total of $35.
The marginal utility from the third hour of windsurfing is 80 and the rent of the windsurfing
equipment is $10 an hour, so the marginal utility per dollar from windsurfing is 8. The
marginal utility from the first hour of snorkelling is 40 and the rent of the snorkelling
equipment is $5 an hour, so the marginal utility per dollar from snorkelling is 8. The marginal
utility per dollar from windsurfing equals the marginal utility per dollar from snorkelling.
b. If Max spent a dollar more on windsurfing and a dollar less on snorkelling than
in part (a), how would his total utility change?
If Max windsurfs another hour, he pays $10 and gains 60 units of utility (the marginal utility
from the 4th hour), which is 6.0 units of utility per dollar. So if he spends a dollar more on
windsurfing, his utility from windsurfing increases by 6.0. If he spends an hour less on
snorkelling, he saves $5 and loses 40 units of utility (the marginal utility from the 1st hour of
snorkelling), which is 8.0 units of utility per dollar. So if he spends a dollar less on snorkelling,
he loses 8.0 units of utility. Overall, spending a dollar more on windsurfing and a dollar less
on snorkelling lowers Max’s total utility by 2.0 units of utility.

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112 CHAPTER 8

c. If Max spent a dollar less on windsurfing and a dollar more on snorkelling than
in part (a), how would his total utility change?
If Max snorkels another hour, he pays $5 and gains 36 units of utility (the marginal utility from
the 2nd hour), which is 7.2 units of utility per dollar. So if he spends a dollar more on
snorkelling, his utility from snorkelling increases by 7.2. If he spends an hour less on
windsurfing, he saves $10 and loses 80 units of utility (the marginal utility from the 3rd hour
of windsurfing), which is 8.0 units of utility per dollar. So if he spends a dollar less on
windsurfing, he loses 8.0 units of utility. Overall, spending a dollar more on snorkelling and a
dollar less on windsurfing lowers Max’s total utility by 0.8 units of utility.
Use the data in Problem 3 to work Problems 9 to 13.
9. If the price of renting windsurfing equipment is cut to $5 an hour, how many
hours a day does Max spend on each activity?
Max will now maximize his total utility by spending 5 hours windsurfing and 2 hours
snorkelling. This combination of windsurfing and snorkelling uses all of Max’s income and
sets the marginal utility per dollar from windsurfing equal to the marginal utility per dollar from
snorkelling.
10. Draw Max’s demand curve for rented windsurfing equipment. Over the price range
from $5 to $10 an hour, is Max’s demand for windsurfing equipment elastic or
inelastic?
From Problem 8 (a), when the price of renting
windsurfing equipment is $10 per hour, Max
rents windsurfing equipment for 3 hours.
From Problem 9, when the price of renting
windsurfing equipment is $5 per hour, Max
rents windsurfing equipment for 5 hours.
These points are on the demand curve in
Figure 8.2. Max’s elasticity of demand for
renting windsurfing equipment is inelastic
because a fall in the price decreases Max’s
total expenditure on renting windsurfing
equipment.
11. How does Max’s demand for snorkelling
equipment change when the price of
windsurfing equipment falls? What is
Max’s cross elasticity of demand for
snorkelling with respect to the price of
windsurfing? Are windsurfing and
snorkelling substitutes or complements for Max?
When the price of windsurfing falls, Max increases the hours he snorkels from 1 hour to 2
hours. Max’s demand for snorkelling increases when the price of windsurfing falls. Max’s
cross elasticity of demand for snorkeling with respect to the price of windsurfing equals (1
hour/1.5 hours)/( $5/$7.50) = 1.00. Windsurfing and snorkelling are complements for Max.

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 UTILITY AND DEMAND 113

12. If Max’s income increases from $35 to $55 a day, how does his demand for rented
windsurfing equipment change? Is windsurfing a normal good? Explain.
To maximize his utility, Max windsurfs for 4
hours and snorkels for 3 hours. Max uses his
$55 such that all of the $55 is spent and
marginal utility per dollar for each activity is
the same. When Max windsurfs for 4 hours
and snorkels for 3 hours, he spends $40
renting the windsurfing equipment and $15
renting the snorkelling equipment—a total of
$55. The marginal utility from the fourth hour
of windsurfing is 60 and the rent of the
windsurfing equipment is $10 an hour, so the
marginal utility per dollar from windsurfing is
6. The marginal utility from the third hour of
snorkelling is 30 and the rent of the
snorkelling equipment is $5 an hour, so the
marginal utility per dollar from snorkelling is 6.
The marginal utility per dollar from
windsurfing equals the marginal utility per
dollar from snorkelling.
Max’s demand for rented windsurfing equipment increases. The quantity of windsurfing
equipment rented at $10 per hour increases from 3 hours (problem 8 (a)) to 4 hours (this
problem). Max’s demand curve for rented windsurfing equipment shifts rightward as shown in
Figure 8.3 from D1 to D2. Windsurfing equipment is a normal good.

13. If Max’s income increases from $35 to $55 a day, how does his demand for
snorkelling equipment change? Is snorkelling a normal good? Explain.
Max’s demand for rented
snorkelling equipment increases.
The quantity of snorkelling
equipment demanded at a price of
$5 per hour increases from 1 hour
(problem 8 (a)) to 3 hours (this
problem). As a result Max’s
demand curve for rented
snorkelling equipment shifts
rightward as illustrated in Figure
8.4 by the shift from D1 to D2.
Snorkelling equipment is a normal
good.

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114 CHAPTER 8

Use the following news clip to work Problems 14 and 15.

Eating Away the Innings in Baseball’s Cheap Seats
Baseball and gluttony, two of America’s favourite pastimes, are merging, with Major
League Baseball stadiums offering all-you-can-eat seats. Some fans try to “set
personal records” during their first game, but by the third time in such seats they eat
normally.
Source: USA Today, March 6, 2008
14. What conflict might exist between utility maximization and setting “personal
records” for eating? What does the fact that fans eat less at subsequent games
indicate about their marginal utility from ballpark food as they consume more?
Utility maximization means that the person will eat until the marginal utility per dollar of food
equals the marginal utility per dollar for all other goods and services. Setting a personal
record implies that the person’s objective is to eat until he or she has eaten more than at past
events and not to maximize his or her utility though, of course, “setting a personal record”
might bring some utility. The fact that fans eat less implies that the marginal utility from
ballpark food decreases as more is consumed.
15. How can setting personal records for eating be reconciled with marginal utility
theory? Which ideas of behavioural economics are consistent with the
information in the news clip?
The marginal utility of food consumption includes not only the “usual utility” from food but also
the utility from setting a food-eating record.
Bounded willpower seems very consistent with the information. Undoubtedly the people who
“set personal records” in the stadium regret their decisions at later dates when they either
have less income to spend than they desire or need to lose weight.

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 UTILITY AND DEMAND 115

Answers to Additional Problems and Applications

16. Tim buys 2 pizzas and sees 1 movie a
week when he has $16 to spend, a movie
ticket is $8, and a pizza is $4. Draw Tim’s
budget line. If the price of a movie ticket
falls to $4, describe how Tim’s
consumption possibilities change.
Figure 8.5 shows Tim’s budget line as BL1.
Pizza is on the vertical axis and movies on the
horizontal axis. If the price of a movie ticket
falls to $4, then Tim’s budget line rotates
outward, as illustrated in Figure 8.5 by the
rotation from BL1 to BL2. Tim’s consumption
possibilities expand.

17. Cindy has $70 a month to spend, and she

can spend as much time as she likes
playing golf and tennis. The price of
an hour of golf is $10, and the price of Hours Marginal Marginal
an hour of tennis is $5. The table per utility from utility from
shows Cindy’s marginal utility from month golf tennis
each sport. 1 80 40
2 60 36
Make a table that shows Cindy’s
3 40 30
affordable combinations of hours 4 30 10
playing golf and tennis. If Cindy 5 20 5
increases her expenditure to $100, 6 10 2
describe how her consumption 7 6 1
possibilities change.
The table showing Cindy’s affordable combinations of hours Hours Hours
playing golf and tennis is to the right. If Cindy increases her playing playing
expenditure, then for each entry of tennis hours in the table, her
golf tennis
hours of playing golf increase by 3 hours. Alternatively, for each
7 0
entry of golf hours in the table her hours of playing tennis increase
by 6. Cindy’s budget line shifts to the right and its slope does not
6 2
change. 5 4
4 6
Use the information in Problem 17 to work Problems 18 to 24. 3 8
18. a. How many hours of golf and how many hours of tennis 2 10
does she play to maximize her utility? 1 12
Cindy plays golf for 5 hours and tennis for 4 hours to maximize 0 14
her utility. This combination allocates all her income and sets the
marginal utility per dollar from golf equal to the marginal utility per dollar from tennis.
b. Compared to part (a), if Cindy spent a dollar more on golf and a dollar less on
tennis, by how much would her total utility change?
If Cindy played another hour of golf, she pays $10 and gains 10 units of utility (the marginal
utility from the 6th hour), which is 1.0 unit of utility per dollar. So if she spends a dollar more
Copyright © 2016 Pearson Canada Inc.
116 CHAPTER 8

on golf, her utility from golf increases by 1.0. If she spends an hour less playing tennis, she
saves $5 and loses 10 units of utility (the marginal utility from the 4th hour of tennis), which is
2.0 units of utility per dollar. So if she spends a dollar less on tennis, she loses 2.0 units of
utility. Overall, spending a dollar more on golf and a dollar less on tennis lowers Cindy’s total
utility by 1.0 unit of utility.
c. Compared to part (a), if Cindy spent a dollar less on golf and a dollar more on
tennis, by how much would her total utility change?
If Cindy spends an hour less playing golf, she saves $10 and loses 20 units of utility (the
marginal utility from the 5th hour), which is 2.0 units of utility per dollar. So if she spends a
dollar less on golf, her utility from golf decreases by 2.0. If she spends an hour more playing
tennis, she spends $5 and gains 5 units of utility (the marginal utility from the 5th hour of
tennis), which is 1.0 unit of utility per dollar. So if she spends a dollar more on tennis, she
gains 1.0 unit of utility. Overall, spending a dollar less on golf and a dollar more on tennis
lowers Cindy’s total utility by 1.0 unit of utility.
19. Explain why, if Cindy equalized the marginal utility per hour of golf and tennis,
she would not maximize her utility.
Cindy would not maximize her utility by equalizing the marginal utility per hour of golf and
tennis because golf and tennis have different prices. Golf is twice as expensive as tennis, so
effectively every unit of utility that Cindy buys from playing golf costs her twice as much as
buying a unit of utility from playing tennis. Equalizing the marginal utilities means that the
marginal utility per dollar from tennis is greater than her marginal utility per dollar from golf.
This inequality means that Cindy can increase her utility if she spends a dollar less on golf
and a dollar more on tennis.
Cindy’s tennis club raises its price of an hour of tennis from $5 to $10, other things
remaining the same.
20. a. List the combinations of hours spent playing golf and tennis that Cindy can now
afford and her marginal utility per dollar from golf and from tennis.
The lists of affordable
combinations are in the first Marginal
and third columns in the table Hours utility per Hours Marginal
to the right. playing dollar from playing utility per
The lists of the marginal golf golf tennis dollar from
utilities per dollar are in the tennis
second and fourth columns in 7 0.6 0
the table. 6 1.0 1 4.0
b. How many hours does 5 2.0 2 3.6
Cindy now spend playing 4 3.0 3 3.0
golf and how many hours 3 4.0 4 1.0
does she spend playing 2 6.0 5 0.5
tennis? 1 8.0 6 0.2
Cindy now plays golf for 4 0 7 0.1
hours and plays tennis for 3 hours. This combination allocates all her income and sets the
marginal utility per dollar from golf equal to the marginal utility per dollar from tennis.

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 UTILITY AND DEMAND 117

21. Use the information in Problem 20 to draw Cindy’s demand curve for tennis. Over
the price range of $5 to $10 an hour of tennis, is Cindy’s demand for tennis elastic
or inelastic?
One point on her demand curve is 4 hours
of tennis when the price is $5 per hour.
Another point is 3 hours of tennis when the
price is $10 per hour. Cindy’s demand
curve is in Figure 8.6. The price elasticity of
demand between these two points on her
demand curve is 0.43, so Cindy’s demand
is inelastic.
22. Explain how Cindy’s demand for golf
changed when the price of an hour of
tennis increased from $5 to $10 in
Problem 20. What is Cindy’s cross
elasticity of demand for golf with
respect to the price of tennis? Are
tennis and golf substitutes or
complements for Cindy?
The quantity of golf Cindy plays falls from 5
hours before the price of tennis increased
to 4 hours after the price increased. Cindy’s demand for golf decreases. Her cross elasticity
of demand is −0.33. Tennis and golf are complements because the cross elasticity of
demand is negative.
23. Cindy loses her math tutoring job and the amount she has to spend on golf and
tennis falls from $70 to $35 a month. With the price of an hour of golf at $10 and of
tennis at $5, calculate the change in the hours she spends playing golf. For Cindy,
is golf a normal good or an inferior good? Is tennis a normal good or an inferior
good?
With an income of $35, Cindy now plays golf for 2 hours and tennis for 3 hours to maximize
her utility. This combination allocates all her income and sets the marginal utility per dollar
from golf equal to the marginal utility per dollar from tennis. Golf is a normal good because
the fall in income leads to a decrease in Cindy’s demand for hours spent playing golf from 5
hours to 2 hours.
Tennis is a normal good because the fall in income leads to a decrease in Cindy’s demand
for hours spent playing tennis from 4 hours to 3 hours.
24. Cindy takes a Club Med vacation, the cost of which includes unlimited sports
activities. With no extra charge for golf and tennis, Cindy allocates a total of 4
hours a day to these activities.
a. How many hours does Cindy play golf and how many hours does she play
tennis?
Cindy plays golf for 3 hours and plays tennis for 1 hour.
b. What is Cindy’s marginal utility from golf and from tennis?
Cindy’s marginal utility from golf and from tennis both equal 40.
c. Why does Cindy equalize the marginal utilities rather than the marginal utility
per dollar from golf and from tennis?

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118 CHAPTER 8

Because the equipment is free, Cindy does not have to allocate her income between the two
activities; instead, she allocates her time between the two activities because time is now the
factor that limits her. Because each activity is in hour increments, Cindy equalizes the
marginal utility per hour and sets the marginal utilities equal to each other.
25. Jim has made his best affordable choice of muffins and coffee. He spends all of
his income on 10 muffins at $1 each and 20 cups of coffee at $2 each. Now the
price of a muffin rises to $1.50 and the price of coffee falls to $1.75 a cup.
a. Can Jim still buy 10 muffins and 20 coffees?
Before the changes in price, Jim spent all his income on muffins and coffee. Jim’s income is
(10 muffins) × ($1 each) + (20 cups of coffee) × ($2 each) = $50. After the change in prices,
the cost of 10 muffins and 20 coffees is (10 muffins) × ($1.50 each) + (20 cups of coffee) ×
($1.75 each), which is $50. Jim can still buy 10 muffins and 20 coffees.
b. If Jim changes the quantities he buys, will he buy more or fewer muffins and
more or less coffee? Explain your answer.
In consumer equilibrium, Jim spends all of his income and buys the quantity of muffins and
coffee such that the marginal utility per dollar is equal for both goods. When the price of a
muffin rises, then at a quantity of 10 muffins, Jim's marginal utility per dollar from muffins
decreases. When the price of a cup of coffee falls, then at a quantity of 20 cups of coffee, Jim's
marginal utility per dollar from coffee increases. As Jim increases consumption of a good, his
marginal utility decreases and his marginal utility per dollar decreases. And as Jim decreases
consumption of a good, his marginal utility increases and his marginal utility per dollar
increases. To move back to consumer equilibrium, Jim decreases the number of muffins he
buys and increases the cups of coffee that he buys.
26. Ben spends $50 a year on 2 bunches of flowers and $50 a year on 10,000 litres of
tap water. Ben is maximizing utility and his marginal utility from water is 0.5 unit
per litre.
a. Are flowers or water more valuable to Ben?
Water is more valuable to Ben because water has a higher total utility. On the margin, an
additional bunch of flowers has larger marginal utility than does an additional 1,000 gallons of
water.
b. Explain how Ben’s expenditure on flowers and water illustrates the paradox of
value.
Flowers are more expensive than water even though water is essential to life. The reason
flowers are more expensive is because people enjoy fewer flowers than they do water.
Because Ben consumes so much water, its marginal utility is quite low even though its total
utility is high. Because so few flowers are enjoyed, their marginal utility is relatively high even
though their total utility is small. Ben sets the marginal utility per dollar equal for all goods, so
the price of water is lower than the price of flowers.
Use the following news clip to work Problems 27 to 29.
Putting a Price on Human Life
Researchers at Stanford and the University of Pennsylvania estimated that a healthy
human life is worth about $129,000. Using Medicare records on treatment costs for
kidney dialysis as a benchmark, the authors tried to pinpoint the threshold beyond
which ensuring another “quality” year of life was no longer financially worthwhile. The
study comes amid debate over whether Medicare should start rationing healthcare on
the basis of cost effectiveness.
Source: Time, June 9, 2008
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 UTILITY AND DEMAND 119

27. Why might Medicare ration healthcare according to treatment that is “financially
worthwhile” as opposed to providing as much treatment as is needed by a
patient, regardless of costs?
Increasing the quantity of healthcare lowers the marginal utility from the last unit of
healthcare. At some amount of healthcare the point is reached such that the marginal utility
per dollar from healthcare is less than the marginal utility per dollar from other goods and
services. At that point the quantity of healthcare being provided is too much and society
would be better off with less healthcare.
28. What conflict might exist between a person’s valuation of his or her own life and
the rest of society’s valuation of that person’s life?
The marginal utility that an individual places on another year of their own life likely
approximates infinity. The marginal utility that the rest of society places on another year of
the person’s life is not as high. The individual’s valuation of their life is much higher than
society’s valuation.
29. How does the potential conflict between self-interest and the social interest
complicate setting a financial threshold for Medicare treatments?
Each individual has a very high marginal utility from an additional year of life. Each
individual’s marginal utility per dollar from extending their life is extremely high and so their
demand will be very high. But the rest of society’s marginal utility per dollar from an additional
year of the person’s life is much lower and the socially interested demand will be much lower.

Economics in the News

30. After you have studied Economics in the News (pp. 194–195), answer the
following questions.
a. If big cups of sugary drinks are banned at restaurants, theatres, and stadiums:
(i) How will the price of an ounce of sugary drink change?
The data show that the larger the container, the lower the price per ounce. If big cups are
banned, then only smaller cups will be available, so the price per ounce will rise.
(ii) How will consumers respond to the change in price?
The higher price decreases the marginal utility per dollar from sugary drinks. In consumer
equilibrium, the marginal utility per dollar from all goods consumed is equal. To restore this
equality, consumers respond to the higher price by decreasing the quantity of sugary drinks
they consume, which raises the marginal utility from a sugary drink.
b. If a tax is imposed on sugary drinks, how does
(i) The marginal utility of a sugary drink change?
The tax has no direct effect on the marginal utility of a sugary drink. However with the tax
imposed, the price of a sugary drink rises and consumers respond by decreasing the quantity
of sugary drinks they consume. The decrease in the quantity of sugary drinks consumed
increases the marginal utility from the last sugary drink consumed.
(ii) The consumer surplus in the market for sugary drinks change?
The consumer surplus, the benefit consumers receive from a good above the price they must
pay for it, decreases. It decreases because, first, the price consumers must pay for a sugary
drink rises, and second, consumers respond to the higher price by decreasing the quantity of
sugary drinks consumed.

Copyright © 2016 Pearson Canada Inc.

120 CHAPTER 8

31. Five Signs You Have Too Much Money

When a bottle of water costs $38, it’s hard not to agree that bottled water is a
fool’s drink. The drink of choice among image-conscious status seekers and
high-end tee-totalers in L.A. is Bling H2O. It’s not the water that accounts for the
cost of the $38, but the “limited edition” bottle decked out in Swarovski crystals.
Source: CNN, January 17, 2006
a. Assuming that the price of a bottle of Bling H2O is $38 in all the major U.S. cities,
what might its popularity in Los Angeles reveal about consumers’ incomes or
preferences in Los Angeles relative to other U.S. cities?
If Bling H2O is a normal good, then the increased popularity in Los Angeles indicates that
incomes in Los Angeles are higher than elsewhere. In addition, the increased popularity of
the drink in Los Angeles indicates that the marginal utility of Bling H2O is higher in Los
Angeles than elsewhere.
b. Why might the marginal utility from a bottle of Bling H2O decrease more rapidly
than the marginal utility from ordinary bottled water?
One of the major attributes of Bling H2O is the “statement” it makes that the consumer is one
of the few who can afford it. But typically a consumer carries around only one bottle of water.
And once one bottle of Bling H2O is purchased, it is easily refillable and can be carried once
more with no loss of status. For both reasons, the marginal utility of a second bottle of Bling
H20 is quite low compared to the marginal utility of the first bottle. Ordinary bottled water, is
purchased more for its hydrating properties than a fashion statement, so its marginal utility
falls more slowly because its marginal utility is derived from its hydration.
32. How to Buy Happiness. Cheap
On any day, the rich tend to be a bit happier than the poor, but increases in
average living standards don’t seem to make people happier. The average
American’s income is up 80% since 1972, but the percentage describing
themselves as “very happy” (roughly a third) hasn’t changed. As living standards
increase, most of us respond by raising our own standards: Things that once
seemed luxuries now are necessities and we work harder to buy stuff that
satisfies us less and less.
Source: CNN, October 1, 2004
According to the news clip,
a. How do widespread increases in living standards influence total utility?
Utility is an arbitrarily measured variable that tells us how people value different bundles of
goods at a point in time. The news clip tells us that happiness has not increased with increased
consumption. If happiness equals utility, the news clip implies that total utility has remained
constant as living standards increased.
b. How do total utility and marginal utility from consumption change over time?
Utility is measured on an arbitrary scale, and we can reset the scale every day. Total utility can
be used only to compare alternative situations at a given point in time. We know that marginal
utility per dollar is equal for all goods. To find out what has happened to marginal utility over
time, we need to know how prices and quantities have changed, and this information is not
provided in the news clip.

Copyright © 2016 Pearson Canada Inc.

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