University of Toronto ECO100: Introductory Economics

Department of Economics Robert Gazzale, PhD

Solved Problems: Economists Way of Thinking

Version With Solutions

1. You have a credit at the iTunes store expiring today. Realizing that your music collection
is woefully lacking in jazz classics, you decide to use this credit to purchase jazz albums. In
preparation for spending your iTunes credit, you wrote down Table 1, which indicates the
enjoyment value (in dollars) you would get from each of 5 albums.

Artist Album Value

Ella Fitzgerald and Louis Armstrong Ella and Louis $11
The Thelonious Monk Quartet Monks Dream $13
The Dave Brubeck Quartet Time Out $15
Charles Mingus Ah Um $17
John Coltrane Blue Train $19

Table 1: Your enjoyment values for a number of the best jazz albums of all time.

Assume that each album costs $10. Further assume that that the only reason you are pur-
chasing music is because you have this credit: due to the fact that you are a poor University
student, you are not willing to spend any other money you may have on music. We of course
assume that you are perfectly rational as defined by an economist.

(a) Thinking you have $20 in credit, what albums do you place in your shopping cart?
Suggested Solution: You choose the two albums with the largest enjoyment value:
Coltranes Blue Train and Mingus Ah Um.
(b) Before checking out, you realize that you actually have $30 in credit. What albums do
you now have in your shopping cart?
Suggested Solution: You add the album with the next highest enjoyment value,
Brubecks Time Out, to the albums already in your cart (Coltranes Blue Train and
Mingus Ah Um).
(c) You are just about to purchase the albums you identified in the previous question when
you remember Prof. Gazzale telling you that no music collection is complete without
Miles Davis Kind of Blue.1 What is the (opportunity) cost of following Prof. Gazzales
advice and purchasing Miles Davis Kind of Blue?
Suggested Solution: $15. To answer this question, we need to identify what you
rationally give up in order to purchase Miles Davis Kind of Blue. You must remove
1 of the albums from your shopping cart, and you are of course going to remove the
album giving you the smallest enjoyment value: Brubecks Time Out. (Alternatively, if
you purchase Kind of Blue, you only have $20 to spend. In question 1a, you found that
you would purchase Coltranes Blue Train and Mingus Ah Um if you only had $20 to
spend.)
(d) Helpful to Think About I Prof. Gazzale has been accused of writing wordy problem
set questions. Why was it necessary for him to specify that the credit expires today
in order for you to be able to answer these questions? (Translation: What might you do
if the credit does not expire today?)
1
For the record, no music collection is complete without Miles Davis Kind of Blue.

20160927: Page 1 Economists Way of Thinking: Problems: Solutions

University of Toronto ECO100: Introductory Economics
Department of Economics Robert Gazzale, PhD

Suggested Solution: If the credit does not expire today, you might choose to save
some of your credit for later use. For example, if you know that an album with an
enjoyment value of $20 will be released next week and you are reasonably patient, you
would only purchase 2 albums now.
(e) Helpful to Think About II Why was it necessary for him to specify that you are
rationally only willing to purchase music with the iTunes credit (i.e., you will not use
any other money you have)?
Suggested Solution: If this is the case, you might rationally purchase more than
three albums. For example, if Prof. Gazzale also told you that the total enjoyment value
of the last 5 coffees you consume in a month was $14 (and each coffee costs $2), then
the opportunity cost of purchasing Davis Kind of Blue would be $14, as you would keep
Brubecks Time Out in your shopping cart and instead cut back on coffee.
By assuming that you rationally would only use the iTunes credit to purchase music, we
are assuming that the enjoyment value you get from any $10 of real money is at least
$15.

2. Assume each glass of wine costs $10. Assume Table 2 gives the enjoyment benefit (i.e., value
as assessed by a consumer) of each glass of wine consumed in a given month. Thus while the
first glass of wine each month is valued at $18, the second glass is valued at $16, the third at
$14, etc.

Marginal Total Average

Quantity Benefit Benefit Benefit
1 $18 $18 $18
2 $16 $34 $17
3 $14
4 $12
5 $10
6 $8
7 $6
8 $4
9 $2
10 $0

Table 2: Benefit (i.e., value assessed by consumer) of each glass of wine.

(a) If the consumer purchases 2 glasses of wine in a month:

i. What is the net benefit of the second glass of wine?
ii. What is the consumers total net benefit from two glasses of wine?
Suggested Solution: First glass: $18-$10=$8. Second glass: $16-$10=$6. Two
glasses: $8+$6=$14.
Alternatively: ($18 + $16) ($10 + $10) = |{z}
$14
| {z } | {z }
total benefits total costs net benefit

(b) Assume the consumer is perfectly rational and follows the rule keep doing something
as long as the benefit is at least as large as the cost.

20160927: Page 2 Economists Way of Thinking: Problems: Solutions

University of Toronto ECO100: Introductory Economics
Department of Economics Robert Gazzale, PhD

i. How many glasses of wine does she drink every month?

ii. What is the consumers total net benefit from wine?
Suggested Solution:
i. She drinks 5 glasses each month.
ii. Total net benefit=$8+$6+$4+$2+$0=$20
(c) Suppose instead that the consumer followed the rule keep doing something as long as
the average benefit is at least as large as the average cost. What would be her total
net benefit if she followed this rule?
Suggested Solution: For any quantity, average cost equals $10. When the consumer
consumes 9 glasses of wine, her average benefit equals to $10. This means her total
benefit equals 9 $10 = 90, while her total costs equal 9 $10 = 90. Her net benefit is
thus zero. Clearly, this is not a good rule to live by . . .
(d) Assume now that wine need not be purchased in discrete increments. (Translation: it is
now possible to purchase 1.99873979 glasses of wine.)
i. What is the equation for the marginal benefit schedule presented in Table 2? (That
is, what is the equation for M B(Q) that gives me $18 for Q = 1, $16 for Q = 2,
etc.)
ii. If each glass costs $10, what is the equation for marginal cost, M C(Q)?
Suggested Solution:
i. M B(Q) = 20 2Q
ii. M C(Q) = 10
(e) Using the equations from question 2d:
i. In a graph with $ on the vertical axis and Q on the horizontal axis, sketch M C(Q)
and M B(Q).
ii. Solve for Q , the quantity where M C(Q ) = M B(Q ).
iii. Solve for the area between the M C(Q) and M B(Q) lines. (Translation: Find the
consumers total net benefit from wine if she consumes Q units.)
Suggested Solution:
i. See Figure 1.

Figure 1: Marginal benefits and costs.

20160927: Page 3 Economists Way of Thinking: Problems: Solutions

University of Toronto ECO100: Introductory Economics
Department of Economics Robert Gazzale, PhD

ii.

M C(Q ) = M B(Q ) (1)

10 = 20 2Q (2)

2Q = 10 (3)

Q =5 (4)
bh 510
iii. 2 = 2 = 25
(f) Explain why Q maximizes her total net benefit. That is, explain why
i. Purchasing more than Q units decreases her total net benefit; and
ii. Purchasing fewer than Q units decreases her total net benefit.
Suggested Solution:
i. For any unit greater than Q = 5, the cost exceeds the benefit, and we would thus
need to subtract this area from the area shaded in grey.
ii. For any unit less than Q = 5, the benefits exceed the cost, and thus consuming this
units would add to net total benefit. Graphically, if she stopped consuming before
Q = 5, the shaded area in Figure 1 would be smaller than it currently is.

3. You arrive at the $50 Store with $50 gift card that will expire at the end of the day, but no
cash and no credit/debit cards. The price of everything at the $50 Store is $50. You see a pair
of jeans which would give you $70 in enjoyment value; a sweater which would give you $80 in
enjoyment value; and a pair of shoes with would give you $90 in enjoyment value. Everything
else is pretty vile, and you are a busy person who cannot return to the store before the gift
card expires. We of course assume perfect rationality as defined by the economist.

(a) While the next few questions will have you analyze the situation more formally, I do
hope that the more formal analysis supports your answer to this question: What do you
leave the $50 store with?
A Your soon-to-expire $50 gift card.
B The pair of jeans
C The sweater
D The shoes
Suggested Solution: D.
(b) What is the cost2 of using the gift card to purchase the jeans?
Suggested Solution: Buying the jeans means you give up buying the sweater whose
value is 80 and the shoes whose value is 90. Finding the opportunity cost requires finding
the value of the best alternative: if you do not buy the jeans, you would choose the shoes
over the sweater. Thus the opportunity cost is 90.
(c) What is the cost of using the gift card to purchase the sweater?
Suggested Solution: Buying the sweater means you give up buying the jeans whose
value is 70 and the shoes whose value is 90. Finding the opportunity cost requires finding
the value of the best alternative: if you do not buy the jeans, you would choose the shoes
over the jeans. Thus the opportunity cost is 90.
2
We are economists, cost includes any and all opportunity costs . . .

20160927: Page 4 Economists Way of Thinking: Problems: Solutions

University of Toronto ECO100: Introductory Economics
Department of Economics Robert Gazzale, PhD

(d) What is the cost of using the gift card to purchase the shoes?
Suggested Solution: Buying the shoes means you give up buying the jeans whose
value us 70 and the sweater whose value is 80. Finding the opportunity cost requires
finding the value of the best alternative: if you do not buy the jeans, you would choose
the sweater over the jeans. Thus the opportunity cost is 80.
(e) Use the do it as long as the benefit outweighs the cost rule to explain the contents of
your shopping bag as you exit the $50 Store.
Suggested Solution: As the shoes are the only item whose benefit exceeds its costs,
it is the only thing in your bag.

20160927: Page 5 Economists Way of Thinking: Problems: Solutions