Economics Homework Four - Model

1. A consumer's overall satisfaction is expressed in economics as his _________________.

2. Suppose you see a sleek-looking used sports car and you immediately want to buy it. You think to yourself, "I can paint that car and fix it up so it looks brand new!" You like it so much that you would very work hard for a year and save up $10,000 to buy it. You ask the owner how much he'd sell the car for, and he says $9,000. If you buy it for $9,000, then what is your "consumer surplus"? What does that concept mean?

3. Suppose your favorite hobbies are reading books and hiking, and imagine that they have the following values for marginal utility. The first hour that you hike gives you lots of utility: 10 units. But as you start to tire, you enjoy and benefit from it less. The next hour of hiking is worth only 8 units of utility (in other words, it has a marginal utility of 8 units rather than 10), and the next hour of hiking is worth only 5 units, and then 3, then 1, and then zero for the next hours, in that order. Your marginal utility for reading books does not decline so quickly. In the first hour, reading a book gives you utility of 6 units; the next hour is worth 5 units; the next hour is worth 4 units; and then 3, 2, 1 and 0. Suppose that you have 5 extra hours today. How should you spend those hours on hiking and reading in order to maximize your utility, and what will be your total utility for those 5 hours? Explain your answer.

4. Suppose you plan to buy a brand new car for $25,000. When you do to the car dealership to make your purchase, you notice that there is a car on the lot that looks brand new but not longer has the sticker price on it. The dealer says it was returned by someone after driving it only 100 miles. You like the color and ask if you can buy it. The dealer, seeing that you’re so interested, says he’ll sell it to you for the same price as a brand new car that has never been sold. You’re willing to buy it at full price, and do not mind one bit that someone else used it briefly and returned it. But you notice that other people (the “market”) would not pay full price for a returned car. Relying on the “market” rather than your personal preferences, what should you tell the dealer in order to maximize your benefits from your purchase?

You tell the dealer that you are willing to pay $20,000 for the car that was used because the value of that used car drastically decreases when it was ridden. When the dealer realized that his chance to take advantage of your personal preferences has vanished he will sell you the car because it would benefit him too. The one thing about cars which helps the consumer but not the seller is that the first couple of miles decrease the value by a lot. It is cheaper to buy a car that was used slightly than pay for a new overly price car. Even though the dealer did not get as much as he could have if you had followed your personal preferences, he should consider himself very lucky because it is hard to sell a use car that was specially made for someone else. Your overall consumer surplus was increased by $5,000 because instead of following your personal preferences (in which you would gain now consumer’s surplus except the happiness of owning a new car) you followed the “market”. The free market is always there to help you out. (Veronika)

5. Explain why the shape of an indifference curve for two goods that are perfect substitutes is a straight line going from the upper left down to the lower right. Extra credit: why must its slope be negative 1?

6. Describe either the "income effect" or the "substitution effect." Take your pick.

7. Charity is based on the foundation of a successful free market. Or is a successful free market based on a foundation of charity? Describe and explain which is the cart, and which is the horse (in other words, which comes first or is most important, charity or the free market).

Charity comes first because all free markets need to have a charity foundation to thrive. But in my opinion they go hand in hand, you can't have one without the other. In one place charity may come first and in another place the free market may come first but in both places they will have both charity and the free market at some point. (Seth)

Honors

Write in about 300 of your own words on one or more of the following topics:

8. "A penny saved is a penny earned!" In fact, once taxation is taken into account, "a penny saved is almost two pennies earned!" Discuss one or both of these quotations.

9. 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.

10. Prove the Law of Demand as simply as you can, perhaps using the assumption that the consumer always tries to maximize marginal utility.

11. Discuss the Irish Potato Famine between 1846 and 1849, and whether you think potatoes were an "inferior good" then.

Extra Credit for Anyone

12. Explain whether goods X or Y are perfect substitutes or complements or something else for the indifference curves below, and why: