ECN 101 Fall 2007 PROBLEM SET 4

1.

Aye enjoys bowling and miniature golf. The extent of her enjoyment is revealed by the following utility schedules. Game sof bowling 1 2 3 4 Total utility 8 12 15 17 Games of miniature golf 1 2 3 4 Total utility 12 20 24 26

(a) Compute Ayes marginal utility for each activity. (b) Assume initially that the price for both bowling and miniature golf is TL2 per game. Given a budget of TL6, how many games of each should Aye play? (c) Now suppose the price per game of bowling is TL1, half the price of miniature golf. With a TL6 budget, how many games of each would maximize Ayes utility? Justify your answers. (d) Based on the above information, plot Ayes demand for bowling. 2. Suppose the price of movie tickets rises. (a) According to the substitution effect, how are consumers likely to respond? (b) How will the income effect influence quantity demanded? On what does your answer depend? A consumers income is $50. Food costs $5 per unit and film costs $2 per unit. (a) Draw the budget line. Choose a point e fort he optimal initial consumption bundle. (b) Suppose now the price of food falls to $2.50. Draw the new budget line and indicate what can be said about the new consumption point if both goods are normal. Label the new consumption point e*. (c) Suppose the price of films also falls to $1. Draw the new budget line and indicate where the consumer now chooses. Label this point e**. (d) How does e** differ from e? Explain yor answer. Suppose Londoners have a given income. They consume a large variety of goods, including petrol and weekend trips to the countryside (a three hour to drive). Now let the price of petrol double. (a) What is the effect on the demand for weekend trips to the counryside? Discuss both the income and substitution effects. (b) Use a demand and supply diagram Assume that Mei has $100 per month to divide between dinners at a Chinese restaurant and nights at Zanzibar, a local pub. Going to Zanzibar costs $20 and eating at the Chinese restaurant costs $10. Suppose that Mei spends two nights at Zanzibar and eats six times at the Chinese restaurant.

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(a) Draw Meis budget constraint and show that she can afford six dinners at the Chinese restaurant and two nights at Zanzibar. (b) Assume that Mei comes into some Money and can now spend $ 200 per month. Draw her new budget cosntraint. (c) As a result of the increase in income, Mei decides to spend eight nights at Zanzibar and eat at the Chinese restaurant four times. What kind of good is Chinese food? What kind of good is a night at Zanzibar? (d) What part of the increase in Zanzibar trips is due to the income effect, and which part is due to the substitution effect? Explain your answer.

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Assume that Joe has $80 to spend on books and movies each month, and that both goods must be puchased whole (no fractional units.) Movies cost $8 each, while books cost $20 each. Joes preferences for movies and books are summarised by the following information: TU 50 80 100 110 116 121 123 MOVIES MU MU/$ No. per month 1 2 3 4 5 6 7 TU 22 42 52 57 60 62 63 BOOKS MU MU/$

No. per month 1 2 3 4 5 6 7

(a) Fill in the figures for marginal utility and marginal utility per dolar for both movies and books. (b) Are these preferences consistent with the law of diminishing marginal utility? Explain briefly. (c) Given the budget of $80, what quantity of books and what quantity of movies will mazimize Joes level of satisfaction? Explain briefly. (d) Draw the budget costraint (with books on the horizontal axis) and identify the optimal consumption of books and movies at point A. (e) Now suppose the price of books falls to $10. Which of the columns in the table must be recalculated? Do the required calculations. (f) After the price change, how many movies and how many books will Joe purchase? (g) Draw in the new budget constraint and identify the new optimal combination of books and movies as point B. (h) If you calculated correctly, you have found that a decrease in the price of books has caused this person to buy more movies as well as more books. How can this be? 7. Number of cookies 1 2 3 4 5 6 7 Total utility 28 52 72 88 96 96 88 Marginal utlility Number of glasses of milk 1 2 3 4 5 6 7 Total utility 20 36 48 56 56 54 48 Marginal utility

(a) Suppose you visit a friends house whose familys policy is all-you-can-eat-and-drink. According to the table, how many cookies and how many glasses of milk will you consume? (b) Suppose the price of cookies at a cookie in the mall is 50 cents each, and the price of milkis $1 per glass. Using your answer in problem 1, calculate the marginal utility per dolar to youat these prices. (c) If you only had $4.50 to spend, would you buy 4 cookies and 2 glasses of milk at the prices charged? Why or why not? (d) If you had $8, how many cookies and glasses of milk would you buy? If you had $14.50, how many of each would you buy?