Economics Model Answers Four

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Introductory: 1. The total utility of a good represents the consumer’s _________________.

Satisfaction.

2. Conservatives say a bad effect of raising the minimum wage is that it causes more students to drop out of school. Why would that happen?

Students are often paid the minimum wage, and the higher that is, the more attractive jobs are to students. More students will want quick money now rather than stay in school and delay their ability to make (more) money later.

Intermediary: 3. A student likes swimming and playing the violin. The first hour she swims she improves by 6 units of utility, and then each successive hour she improves by half the rate of the hour before it. The first hour she practices the violin she improves by 4 units of utility, then each successive hour she improves at a rate of 90% the hour before it. In 3 total hours to practice, how should she maximize her utility?

Her first hour is best spent swimming, to gain 6 units of utility. But her utility from swimming a second hour would be only half, or 3 units. She earns more utility by playing the violin, gaining 4 units of utility. The third hour she has a choice between 90% x 4 = 3.6 units of utility from playing the violin, or 3 units of utility from swimming. She maximizes her utility by playing the violin.

4. How might one’s overall “utility” include religious goals that have nothing to do with money? Be specific.

Spiritual benefits can be part of one's utility. By helping others, it can advance utility with respect to God.

5. Suppose you manage a golf course for profit. You poll your customers and find that, each month, they value their first game at $30, their second game at $20, their third at $10, fourth at $0, and refuse to play any more in the same month. It is impractical to charge based on whether someone has previously played a round this month. How do you best charge your customers?

It's best to offer a monthly package.

6. Bad British economic policies and a fungus wiped out the basic food supply of potatoes in Ireland between 1846 and 1849, killing 500,000 and sending many Irish to the United States. Do you think potatoes might have been an “inferior” good then? What would you expect the income effect of the shortage of potatoes to have been?

An "inferior good" is one that has increasing demand as income decreases. As income decreased in Ireland, it is easy to imagine greater demand for potatoes because that is all people could afford.

The income effect is the increased demand for a good, when its price decreases, due to the consumer having more cash (more real income) from the price decrease. The consumer has more money to spend when the price of the good declines, and he uses some of that extra money to buy more of the good. This effect is larger for goods that consumers depend heavily upon, such as certain foods and gasoline.

Honors: 7. Do you think a Giffen good really exists? Can you see any possible political bias in the claim that Giffen goods exist? Your views, please.

8. Suppose you are a rational consumer who makes purchases by maximizing marginal utility. One day you hear that the price on a good you purchase (e.g., milk), falls by 30%. The Law of Demand says you should buy more of it. Using only the assumption that you maximize marginal utility, prove the Law of Demand as best you can.

Proof of the law of demand (If the price of ‘a’ decreases then the demand for ‘a’ increases) is found through the law of equiproportional marginal benefit (MUa/Pa=MUb/Pb=MUc/Pc). When the price of good ‘a’ decreases (Pa decreases) the Marginal Utility of good ‘a’ (MUa) must also decrease to keep MUa/Pa equal to MUb/Pb and MUc/Pc. To decrease the marginal utility of good ‘a’ you (and all other rational consumers) buy more of it, and this increases the demand for good ‘a’. Therefore if the price of good ‘a’ decreases the demand for good ‘a’ increases. (thanks to Tim S. for that answer)

9. Suppose a friend of yours announced that when he has a choice between a cheaper good made in China and a more expensive good made here, he will buy the latter based on his opposition to communism. Is he being irrational?

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