Additional Problem 1 Answers: Utility Analysis
Assume that Maxi Mizer is trying to decide which combination of ice cream cones, Good A, and magazines, Good B, she should purchase with her limited income of $20. Maxi’s preferences for ice cream and magazines, Goods A and B, are given in the table below. Further assume that the prices of ice cream cones and magazines, Goods A and B, are $2 and $4 respectively.
Unit of Good / Marginal Utility of Ice Cream Cones (Good A) / MUAPA / Purchase Order
Price of
B=4 B=2 / Marginal Utility of Magazines (Good B) / MUB
PB / B=$4 / MUB'
PB' / B=$2
1 / 20 / 10 / (2) / (6) / 48 / 12 / (1) / 24 / (1)
2 / 16 / 8 / (4) / (7) / 40 / 10 / (2) / 20 / (2)
3 / 14 / 7 / (8) / 36 / 9 / (3) / 18 / (3)
4 / 12 / 6 / (9) / 32 / 8 / (4) / 16 / (4)
5 / 10 / 5 / 24 / 6 / 12 / (5)
6 / 8 / 4 / 12 / 3 / 6 / (9)
7 / 6 / 3 / 8 / 2 / 4
a) How many ice cream cones and magazines will Maxi purchase? ___2A, 4B___
Why?
Maximum Total Utility = 192
Total Expenditures =
b) Now assume that the price of magazines falls to $2. How many ice cream cones and magazines will Maxi purchase now? ______
4A, 6B
Maximum Total Utility = 254
Total Expenditures =
c) On the basis of the information determined so far, determine the demand curve for magazines. Provide a graph of the demand for magazines.
PB = $4 QB = 4
PB' = $2 QB' = 6
Does the demand for magazines follow the “law of demand”? ____Yes___ (Yes;No) Give reasons to explain the “law of demand” and explain them briefly.
1) Diminishing Marginal Utility
2) Income Effect
3) Substitution Effect
d) Compute the price elasticity of demand for the price change for magazines indicated in part (b). Interpret this elasticity coefficient and provide the formula for calculations for this price elasticity.
P1 = $4 Q1 = 4
P2 = $2 Q2 = 6
Q2 – Q1Q2 + Q1
2 / = / 6-4
5 / = / 2 / · / 3 / = / -6 / = / -3 / = / -.60
P2 – P1 / -2 / 5 / -2 / 10 / 5
P2 + P1
2 / 3
Demand Inelastic
A 1% ê P è .6% é QD + visa versa