Economics Homework Four - Model

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

total utility (Lucy)

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)
My "consumer surplus" is $10,000-$9,000=$1,000. The consumer surplus is the demand price minus the price paid. Meaning the money you're willing to pay minus the money you actually have to pay. The surplus would be the money you were willing to pay but didn't have to, therefore you keep it. (Leigh)

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)
I would spend 3 hours hiking and 2 hours reading which would give me a total of 34 utility if i spent my whole 5 hours hiking I would have only 27 utility and if I spent the whole time reading I would only have 21 utility. By balancing my two favorite hobbies I would maximize my utility. (Isaac)

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)

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?

... [T]here is perfect proportion between the two goods - if you lose three chocolate bars, you will receive three peanut butter bars, thus graphing a perfect diagonal line from the upper left tot he lower right of the graph. (Mary)
... The slope of the line must be negative one because that way if you take away one of good one, and add one of good two or the other way around, your level of happiness stays the same. (Nat)
... The reason that the slope is negative one is that, for two or more goods or services which are perfect substitutes, when you lose one good or service, you need to obtain one of the other goods or services in order to maintain the same total utility. (Dermot)

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)
The income effect is an economic term used to describe the changes of price in a demand or service. When the price of a good decreases it allows the buyer to save more money or use that money to buy more of the good. (Amanda)
The “substitution effect” starts off when the price a good increases. Since people do not want to pay the higher price, the substitute of the item starts to sell more due to its lower price. As a result the demand for the good with the higher price decrease as the demand for the lower priced substitute increases. (Leonard)
When the price of a good increases, or the price of it's substitute decreases, the demand for the initial good lessens. If the companies who make butter all decided to double the price of their product, less people would buy butter. Likewise, if the people who made margarine decided to cut their price in half, more people would buy that instead of butter. This is called the substitution effect, and it is part of the reason why the Law of Demand is true. (Michelle)

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)
Free market is the most important aspect in the economic world. In the free market, people are attracted to the good or service because there will be a reciprocation. Charity is the giving away of a good or service without gaining a reward. Free market gives an incentive for people to work for gain and then give charity to those who are in need. (Allie)
A successful free market is the basis of charity because people need a good job in order to provide for themselves and the excess money they obtain can be donated to charity. Whereas, if people were to donate to charity when they were jobless, what would happen to them? They themselves would eventually become in need of charity. (Alexander)


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.

"A penny saved is a penny earned!" is an insightful quote that relates to all of our financial lives. It describes how by being frugal you are actually earning money as you go along. For example, let’s say you badly wanted an ice cream cone one hot summer day and there were two ice cream parlors nearby. You knew that one of them was cheaper than the other even though the ice cream was the same quality. Instead of going to the popular expensive ice cream parlor, you decide to save $1 by going to the less expensive store to buy ice cream. In the end, you have increased your income amount by $1 which you can use in a more useful way. If you would have gone to the popular ice cream store you would have spent an extra dollar, which you would have to work to earn back. So instead of spending an extra dollar for an atmosphere with lots of people you now have earned a dollar without having to work for it. (Veronika)

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.

... Yes, I believe they were. Why? Because an inferior good is a good that can be substituted in when another good becomes too expensive [due to a decrease in income]. The potatoes in Ireland can be considered inferior goods because they were the cheapest possible food available in the country. The people lived on potatoes; breakfast, lunch and dinner would be some for of baked potatoes. Potatoes were also the easiest crops to grow. ... (Kathleen)

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: IndifferenceCurve2.gif

They are perfect complements. The indifference curve shows that even if you have 5 extra of "good Y" you still remain indifferent because the good is not useful without the same amount of "good X." (Kathleen)