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?

Your consumer surplus would be $1,000. The consumer surplus is the difference between what you paid, and what you would have paid. (Anna)

... The consumer surplus is the total benefit which a buyer gets when buying a good. For example, if someone wanted a new laptop so badly that he was willing to pay $1800 for it, and he bought it for $1500, then his consumer surplus is $300. Consumer surplus = total benefit - total cost (Mark)

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.

I would spend 3 hours hiking and 2 hours reading. That would be 10+8+5+6+5=34 hour’s total utility. the decrease in marginal utility between the two activities cross each other at 5 units, so that is about as low as you want to go for hiking, since the next decline is a lot less than the upper levels of utility for reading, so we'll substitute reading for hiking at that point. If you cross the two decline slopes you want to choose the points above the cross to maximize utility. (Aran)

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?

In order to get the higher consumer surplus, you should tell the dealer to sell it to you at the price you would have payed for it on the free market,instead of telling him you would buy it for the brand new price. This way the total benefit cost (free market) - total cost (full price) = consumer benefit ( how much money you were saving because you were buying the car for less then you planned). (Deborah)

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.

The income effect is the wealth that you gain or lose when the price of an item changes. For example, if hamburger is on sale for $.99 per pound vs $1.99 a pound, the effect is that I am gaining $1 and will purchase more hamburger as a result. (Shanna)

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)

I think charity relies on the free market because if the free market did not exist, then charity would not exist. (Trish)

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.

A Giffen good may exist under certain conditions, such as when raising the price creates an illusion of better quality. I would say that the potatoes, rice, and tortillas are not really Giffen goods because they are already the primary food source for poor people. When prices go up in general, the ratio of cheap food to expensive food may very well be just about the same. It is possible that demand will go up for cheaper foods when all prices are raised, however, though I don’t think by very much. Political bias could be a reason for claiming the existence of Giffen goods, but I don’t think it is. Researching into the possibility of Giffen goods is worthy and should not just be dismissed as confusing the laws of the free market. Every rule has an exception, after all, and the exceptions prove the rule! (Addison)

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

People always want to acquire as much as possible with as little effort as possible, maximizing their consumer surplus. Therefore, if two identical widgets are for sale at $10 and $15, respectively, any rational person will purchase the $10 one, as it gives them another $5 to use for something else. If they want more than one, they can spend $30 and get three rather than two by purchasing the cheaper ones. (Duncan)

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: