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Seminar 2 Answers

The document discusses several economic concepts: 1) Diminishing marginal utility and how it relates to demand curves. Consumer surplus is gained as marginal benefit exceeds marginal cost up until a point of equilibrium. 2) Indifference curves for individuals with different preferences for coffee and pizza. Preferences are mapped based on whether goods are liked or disliked. 3) Effects of a price change for an inferior good (sausages) on consumer behavior, showing a substitution effect but negative income effect.

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71 views8 pages

Seminar 2 Answers

The document discusses several economic concepts: 1) Diminishing marginal utility and how it relates to demand curves. Consumer surplus is gained as marginal benefit exceeds marginal cost up until a point of equilibrium. 2) Indifference curves for individuals with different preferences for coffee and pizza. Preferences are mapped based on whether goods are liked or disliked. 3) Effects of a price change for an inferior good (sausages) on consumer behavior, showing a substitution effect but negative income effect.

Uploaded by

2972794796
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Principles of Economics Seminar 2

1.

Define diminishing marginal utility and explain how it relates to demand for
goods and services.

MU is the utility an individual is obtains from one extra unit of consumption.


Neo-classical economists suggested that you can value marginal utility - the
price consumers were prepared to pay for one more unit of the good.

The consumer surplus gained by the consumer is shown by the turquoise shaded
area.

The consumer would buy the good until Marginal Benefit = Marginal Cost of
consuming the last unit.. We are assuming here that the Marginal Utility ( the
MU) of money was constant. This does allow the use of MU to derive a demand
curve for an individual. Market demand can be produced by aggregating the
individual demand curves.

2.
Draw indifference curves that represent the following individuals’ preferences
for Coffee and Pizza. Clearly show the direction in which the consumer’s
utility is increasing.

a.

Simon dislikes both coffee and pizza.

This implies that indifference curves will bow towards the direction of
increasing satisfaction.

Since Simon dislikes both goods, his set of indifference curves will be bowed
inwards towards the origin, as opposed to the usual case where more is
preferred to less. Since he dislikes both goods, his satisfaction is increasing in
the direction of the origin, zero consumption of both.

This also implies that given any two bundles between which the consumer is
indifferent, that is the “average” of the two bundles, will preferred or at the very
least will leave him at least as well off.

b.

John likes Coffee and dislikes Pizza. If he is given Pizza he will not eat it.

Pizza is a neutral good here, and neither satisfaction nor dissatisfaction is


obtained by consuming it. It is simply irrelevant. However, more coffee does
increase John’s satisfaction. His satisfaction increases in the upward
direction.
c.

Adam likes Coffee and dislikes Pizza. If he is given Pizza he will eat it to be
polite.

Since Adam will eat the pizza in order to be polite, it can be thought of as an
economic “bad” -an undesirable, which gives ‘disutility’.

When served pizza, he will require more coffee at the same time in order to
keep his satisfaction constant.

d.
Jane likes both goods, but insists on consuming exactly one coffee for every
three slices of pizza that she eats.

The goods are being consumed in a fixed proportion in a fixed proportion so her
indifference curves are L-shaped. She gets no extra satisfaction from having
more of the only one good.

e.

Andrea always gets twice as much satisfaction from a cup of coffee as she does
from an extra slice pizza.

How much extra satisfaction Andrea gains from consumption tells us about the
marginal utilities of the two goods, or about her marginal rate of substitution
(MRS).

If she always receives twice the satisfaction from an extra coffee then her
marginal utility from consuming an extra coffee is twice her marginal utility
from consuming an extra slice of pizza. Her MRS, with coffee on the vertical
axis, is 1/2. Her indifference curves are straight lines with a slope of -1/2.
3.

Sam is a vegetarian, whilst his friend Andrew will eat most food, but he does
regard sausages as inferior goods.

Use indifference curve analysis to consider the effects on both these consumers’
consumption if the price of sausages were to fall.
Although the price of sausages halves, this has no impact on Sam. The result is
called a “corner solution”.

Andrew.

For Andrew there is a positive substitution effect, as the lower price of sausages
leads him to substitute sausages for other goods. However, since he views these
as inferior goods the income effect is negative. In this case, since the good is
inferior, the substitution effect is greater than the income effect and thus the net
effect is positive.

4.

David has a job that pays him £12 per hour of work. If he works more than 35
hours in a week, he gets an overtime premium of 50 per cent, for the extra hors
worked. By nature of the industry he works in there is no weekend work
available for him. You may assume that travelling to and from work and
sleeping take 10 hours per day. He consumes a standard basket of goods
costing £10.

Draw his budget line. Will David be likely ever work exactly 35 hours per
week?
Answer

The two goods are relaxation and consumption.

If he spends 10 hours a day sleeping and travelling to work this leaves 14 hours
per day to work or relax, a total of (14*5) = 70 hours.

We may assume consumption will equal earnings.

The equation for the budget line depends on whether he is working overtime.
Let H = hours worked, R = relaxation hours, and C = consumption.

Maximum earnings are I = 12(35) + 18(35) = 1050.

At £10 he can buy 105 baskets of goods.

He has no rest time though.

Then, if H = 35, his income is 12*35 = 420

At £10 each he can buy 42 baskets of goods.

He will then have 35 hours relaxation.

He would never want to work exactly 35 hours with smooth indifference curves.

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