ECO501 – Principles of Economics

Topic 4 – Household and Consumer Decisions

Activity 4.1 - Solutions
A. Multiple Questions Answers
1–A 2–B 3–B 4–B 5–C 6–A 7–C 8–A 9–C 10 – D

11 – B 12 – A 13 – A 14 – C 15 – A 16 – A 17 – A 18 – C 19 – C 20 – D

B. Short-Answer and Discussion Questions Answers

1. How is a budget line similar to a production possibilities frontier? How do they differ?
Answer: Both the budget line and the production possibilities frontier illustrate limits. The
budget line describes the limits to consumption possibilities; the production possibilities
frontier describes the limits to production possibilities. A consumer is unable to consume
combinations of goods that lie beyond his or her budget line. Similarly, a nation is unable to
produce combinations of goods that lie beyond its production possibilities frontier.
Topic: Budget line
Skill: Level 2: Using definitions
Section: Checkpoint 13.1
Status: Old
AACSB: Reflective thinking

2. The table above has different combinations of hamburgers and hot dogs that Alex can buy.
After labeling the axes, graph Alex's budget line in the figure, putting hot dogs on the x-axis.

a. Alex's income is $8 per day. What is the price of a hot dog? Of a hamburger?
b. What is the slope of the budget line?

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Answer:

The figure above has Alex's budget line.

a. The price of a hot dog is $1 and the price of a hamburger is $2.
b. The slope of the budget line is 1/2 of a hamburger per hot dog.
Topic: Budget line
Skill: Level 3: Using models
Section: Checkpoint 13.1
Status: Old

3. Sherry is on vacation and wants to bring souvenirs home to family and friends. Her
souvenir budget is $100, and she can choose between T-shirts, which cost $20 each, and key
chains, which cost $5 each.
a. Draw a graph of Sherry's budget line in the figure below.
b. What is the slope of Sherry's budget line? How does that slope represent an opportunity
cost? Suppose that Sherry now finds a store where T-shirts are on sale for $10 each. (Key
chains still cost $5 each).
c. Draw the new budget line in the figure.
d. What is the slope of the new budget line? How has the opportunity cost changed?
Answer:

a. The budget line is in the figure above and is the budget line labeled BL1.

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b. The slope of the budget line is 20 key chains divided by 5 T-shirts, which equals 4 key
chains per T-shirt. 4 key chains per T-shirt is an opportunity cost because it represents the
quantity of key chains that must be given up to acquire one more T-shirt.
c. The new budget line is in the figure above and is labeled BL2.
d. The slope of the new budget line is 2 key chains per T-shirt, which means that the
opportunity cost of one T-shirt is now 2 key chains, rather than 4. Thanks to the new store,
the opportunity cost of a T-shirt has fallen.
Topic: Budget line, change in price and change in budget
Skill: Level 3: Using models
Section: Checkpoint 13.1
Status: Old
AACSB: Analytical thinking

Activity 4.2 - Solutions

A. Multiple Questions Answers
1 – A 2 – E 3 – A 4 – C 5 – B 6 – A 7 – D 8 – C 9 – C 10 – B
11 – B 12 – C 13 – C 14 – A 15 – D 16 – C 17 – E 18 – A 19 – B 20 – A

21 – B 22 – A 23 – B 24 – C 25 – E 26 – A 27 – D 28 – A 29 – B 30 – B

B. Short-Answer and Discussion Questions Answers

1. What is the utility-maximizing rule?
Answer: The utility-maximizing rule states that for a person to maximize utility, the person
must allocate (spend) his or her entire budget and consume the quantities of goods and
services so that the marginal utility per dollar from each good or service is equal to the
marginal utility per dollar from all the other goods and services.
Topic: Maximizing utility
Skill: Level 2: Using definitions
Section: Checkpoint 13.2
Status: Old
AACSB: Written and oral communication

2. To maximize utility, why does a consumer consume the combination of goods that equates
marginal utility per dollar from the different goods rather than just equating the marginal
utility of the different goods?
Answer: The consumer equates the marginal utility per dollar from the goods because goods
have different prices. For instance, the marginal utility from a Porsche might be 120,000 units
and the marginal utility from a Hyundai might be 60,000 units. The consumer certainly
prefers the Porsche to the Hyundai because the former has a greater marginal utility than the
latter. However, we did not consider the prices. If the Porsche costs $120,000 and the
Hyundai costs $10,000, the marginal utility per dollar from the Porsche is 1 and the marginal
utility per dollar from the Hyundai is 6. A Hyundai gives the consumer more utility per
dollar. Thus when maximizing total utility, the consumer compares the marginal utility per

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dollar not the marginal utility.
Topic: Maximizing utility
Skill: Level 3: Using models
Section: Checkpoint 13.2
Status: Old
AACSB: Written and oral communication

3. The table above gives Sam's marginal utility schedule for bananas and apples. Sam's fruit
budget is $10.
a. If bananas cost $1 per pound and apples cost $2 per bag, what is Sam's marginal utility
per dollar for all quantities of both goods?
b. What is the utility maximizing combination of bananas and apples for Sam?
c. If the price of bananas increases to $2 per pound, how does Sam's marginal utility per
dollar for bananas change?
d. At the banana price of $2 per pound, what is the new utility maximizing combination of
bananas and apples for Sam?
e. List two points on Sam's demand curve for bananas.

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Answer:

a. The table above has Sam's marginal utility per dollar for bananas and apples.
b. Sam's utility maximizing combination of bananas and apples is 4 pounds of bananas and
3 bags of apples. This quantity allocates (spends) his budget and equates the marginal utility
per dollar from bananas and apples.

c. The table with Sam's new marginal utility per dollar from bananas is above.
d. Sam's new utility maximizing combination of bananas and apples is 2 pounds of bananas
and 3 bags of apples.
e. When the price of a pound of bananas is $1, the quantity demanded is 4 pounds and when
the price rises to $2, the quantity demanded decreases to 2 pounds.
Topic: Marginal utility and the demand curve
Skill: Level 4: Applying models
Section: Checkpoint 13.2
Status: Old
AACSB: Analytical thinking