Assignment

Business Economics

Solution

Activity 4: Background to Demand

MS-IBF (IBA-CEIF)

Submitted by:
INSTRUCTOR:
DR. ZEESHAN ATIQUE Rahmat Ullah
SAHB ERP ID: 13697
Email add: Patriotic140@gmail.com

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 Activity 4
Background to Demand

1. The following table shows the total utility that Eleanor derives from visits to the cinema per week.

Visits 1 2 3 4 5 6 7 8

TU () 12 20 25 28 30 31 31 29

MU() 12 8 5 3 2 1 0 2

(a) Fill in the figures for marginal utility.

(b) Draw a graph of the figures for total and marginal utility on the following diagram.

35

30
TU
Total and marginal utility ()

25

20

15

10

0
MU
-5
0 1 2 3 4 5 6 7 8
Weekly visits to the cinema

(c) How many visits to the cinema will she make per week if the price of a ticket is:
(i) 4.00......................................................................3 (beyond 3, price is greater than MU)
(ii) 2.50.....................................................................4 (beyond 4, price is greater than MU)

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2. (Multiple choice)
Total utility will fall whenever
A. marginal utility is falling.
B. marginal utility is rising.
C. marginal utility has reached a maximum.
D. marginal utility is zero.
E. Marginal utility is negative.

3. The following diagram shows the marginal utility (MU) that a consumer gets from consuming
different quantities of a product. Assume that the current market price of the product is P.

Marginal utility,
Price ()

(1) MU = P
P

(2)
(3)
MU
Q Quantity purchased

(a) Why is the optimum consumption point at Q?

Because MU = P (consumer surplus is maximised)
(b) What area(s) represent(s) total utility at Q?.........................1 + 2 (area under MU curve at Q)
(c) What area(s) represent(s) the consumers total expenditure at Q?.............................2 ( P Q)
(d) What area(s) represent(s) the consumers total consumer surplus at Q?
1 (= TU Texp)

4. How much of a good will people buy? If they wish to maximise their self-interest (what is known
as rational behaviour), they will compare the marginal utility they expect to get from consuming
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 the good with the price they have to pay. This will involve perceiving marginal utility in money
terms (i.e. how much an extra unit of the good is worth to them).
The table below shows marginal utility a person gets from consuming different quantities of a
good. Assume that the good sells for 10.

MarginalutilityforpersonYfromgoodX

Quantity Consumed 0 1 2 3 4 5 6

Marginal Utility (s) 25 20 16 12 8 4

(a) What is the persons total utility from consuming 4 units?

73 (= 25+ 20+ 16+ 12).

(b) What is the persons total expenditure from consuming 6 units?

60 (6 units @ 10 each)

(c) What is the persons marginal consumer surplus from consuming a second unit?

10 (= 20 (MU) 10 (P))

(c) What is the persons total consumer surplus from consuming 2 units?

25 (= 45 (TU ) 20 (TE))

(e) At what level of consumption is the persons total consumer surplus maximised?

4 units (TCS = 33)

(f) What is the relationship between price and marginal utility at this level?
P= MU= 10

Clives total utility from his income

5. The figure opposite shows the total utility

that Clive, a first-year degree student,
would get from different levels of annual
income. Assume at the moment that his
annual income (from an allowance from
his parents and some part-time work in a
burger bar) is 4000. Spending this
rationally gives him a total utility of 500
utils.
Assume that he is offered the chance
to gamble the whole 4000 on the toss of
a coin at odds of 2:1 (i.e. if he wins, he TU
doubles his money; if he loses, he loses the
lot).

(a) If he takes the gamble, what will be his utility this year if he wins?
700 utils (with a total income of 8000)

(b) If he takes the gamble, what will be his utility this year if he loses?
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 0 utils (with a total income of 0)

(c) What would be his average expected utility from the gamble?

(700+ 0) 2= 350 utils

(d) Why is it likely that he will not take the gamble, and thus be risk averse?.................................

Because, with a diminishing marginal utility of income, by taking the gamble his average expected
utility (350 utils) is less than by not taking the gamble (500 utils)....................................................

6. Sally, a first-year degree student, lives in lodgings and pays a fixed amount for food and
accommodation. The money she has left over she spends on books and compact discs. Her
preferences between various combinations of books and CDs are shown in the following table.
She is indifferent between the combinations in each of the five sets shown, but has preferences
between sets.
Set 1 Books 40 30 23 16 12 10 6 4 2
CDs 3 5 8 14 19 22 30 37 46
Set 2 Books 33 22 16 13 7 4
CDs 7 14 20 25 37 45
Set 3 Books 40 30 22 20 17 14 11 6 2 1
CDs 1 2 4 5 7 10 13 20 30 37
Set 4 Books 27 20 11 5
CDs 6 10 20 33
Set 5 Books 30 20 16 12 6 3 1
CDs 1 3 4 6 10 14 20

(a) Plot indifference curves on the following diagram corresponding to each of the five sets
above.

Set 2
Set 3 Sets 1, 4
Set 5

(b) Which set would Sally like best?.......................................................................................Set 2

(c) Between which two sets is Sally indifferent?.....................................................Set 1 and Set 4

(d) Which set does Sally like the least? ..................................................................................Set 5

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(e) Given the information in the table, why would Sally not be indifferent between the
combinations in the following set: 36 books & 5 CDs. 23 books & 8 CDs, 12 books & 13
CDs, 3 books & 20 CDs?
Because this indifference curve would cross others (see below).

Set 2
New set Set 3 Sets 1, 4
Set 5

(f) What is Sallys marginal rate of substitution of books for CDs in set 5 for
(i) the fourth CD?................................................................................................................4
(ii) the sixth CD?.........................................................................................................4/2 = 2
(iii) the tenth CD?.....................................................................................................6/4 = 1.5

Now assume that Sally has 300 per year to spend on a combination of books and CDs, and
assume that all the books and CDs she wants cost 10 each.

(g) Draw in her budget line on the diagram on the previous page...................................................

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 (h) What is the optimum amount of books and CDs for her to buy with this 300?
16 books, 14 CDs

40

35

30
Number of books

25

20

15

10

0
0 5 10 15 20 25 30 35 40 45
Number of CDs

(i) Assume now that the price of CDs rises to 20. Draw in her new budget line. See below.

(j) What is the optimum amount of books and CDs per year for her now to buy?
20 books, 5 CDs

7. Match each of the following changes (i) (viii) in an indifference diagram to the causes (a) (h)
below of those changes. (In each case assume that nothing else changes and that units of X are
measured on the horizontal axis and units of Y on the vertical axis.)

(i) A parallel shift outwards of the budget line

(ii) The budget line becomes steeper.
(iii) The indifference curves become flatter.
(iv) A parallel shift inwards of the budget line.
(v) A movement along the budget line to a higher indifference curve.
(vi) A pivoting outwards of the budget line round the point where the budget line crosses
the X axis.
(vii) The indifference curves become steeper.
(viii) A movement along the budget line from an old tangency point to a new one.

(a) An decrease in the price of Y...............................................................................................(vi)

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(b) A shift in tastes towards Y and away from X......................................................................(iii)

(c) A rise in income.....................................................................................................................(i)

(d) A change in the optimum level of consumption resulting from a change in tastes............(viii)

(e) A shift in tastes towards X and away from Y.....................................................................(vii)

(f) An increase in utility resulting from a change in consumption.............................................(v)

(g) A decrease in the relative price of Y.....................................................................................(ii)

(h) A fall in income...................................................................................................................(iv)