Principles of Microeconomics 12th Edition Case Test Bank Download

Principles of Microeconomics 12th
Edition Case Test Bank

Full download at link:
Test Bank: https://testbankpack.com/p/test-bank-for-principles-

of-microeconomics-12th-edition-case-fair-oster-0134078810-
9780134078816/
Solution Manual: https://testbankpack.com/p/solution-manual-

for-principles-of-microeconomics-12th-edition-case-fair-oster-
0134078810-9780134078816/
Chapter 6
Household Behavior and
Consumer Choice
HOUSEHOLD CHOICE IN OUTPUT MARKETS
1. What role do households play in output markets? What role do households play in factor
markets?
Households are the buyers in output markets and are the sellers in factor markets.
Diff: 1 Skill: Conceptual Topic: households

AACSB:
2. What role do firms play in output markets? What role do firms play in factor markets?
158
Copyright © 2017 Pearson Education, Inc.
Chapter 6: Household Behavior and Consumer Choice 159
Firms are the sellers in output markets and are the buyers in factor markets.
Diff: 1 Skill: Conceptual Topic: firms

AACSB:
3. What does the assumption of perfect knowledge include?
It is assumed that households possess knowledge of the qualities and prices of all
goods available in the market and that firms have all available information
concerning wage rates, capital costs, and output prices.
Diff: 1 Skill: Conceptual Topic: perfect knowledge

AACSB:
4. List the characteristics of a perfectly competitive market.
(1.) Many firms, each small relative to the size of the market.
(2.) Homogeneous products.
(3.) Many households, each small relative to the market.
(4.) Households and firms possess all the information they need to make market
choices.
Diff: 1 Skill: Definition Topic: perfectly competitive market

AACSB:
5. What is meant by the term homogeneous products? Give an example.
Homogeneous products are products that are identical to or indistinguishable from

one another. An example would be a grade A, large egg. It is impossible to tell one
farmer's eggs from another.
Diff: 1 Skill: Definition Topic: homogeneous product

AACSB:
6. What are the three basic decisions that any household must make.
Every household must make three basic decisions: (1) how much of each product, or
output, to demand; (2) how much labor to supply; and (3) how much to spend today
and how much to save for the future.

AACSB:
7. Why do firms in perfectly competitive markets have no control over the price of their
products?

160 Case/Fair/Oster, Principles of Microeconomics, 12th Edition
Firms in competitive markets are price takers, because all firms in the market
produce identical products and each firm is small relative to the size of the market.
Raising prices above this price would result in losing all its sales because consumers
perceive the products to be identical. Setting a price below this level would not
increase the number of consumers but only result in a decline in revenue.
Diff: 1 Skill: Conceptual Topic: perfectly competitive markets

AACSB:

8. What are the three basic economic decisions each household must make?
(1.) How much of each product to demand.

(2.) How much labor to supply.
(3.) How much to spend today and how much to save for the future.
Diff: 1 Skill: Conceptual Topic: households

AACSB:
9. What are the three factors that define a household budget constraint. Explain.
Income, wealth, and prices define household budget constraint. The budget constraint
separates those combinations of goods and services that are available from those that are
not. All the points below and to the left of a graph of a household budget constraint make
up the choice set, or opportunity set.

AACSB:
10. List six factors that influence the quantity of a good or service demanded by a household.
(1.) The price of the product.

(2.) The income available to the household.
(3.) The household's level of accumulated wealth.
(4.) The prices of other products available.
(5.) The tastes and preferences of the members of the household.
(6.) The household's expectations concerning future income, prices, and wealth.
Diff: 1 Skill: Conceptual Topic: determinants of demand

AACSB:
11. What is a budget constraint?
A budget constraint is the limit imposed on household choices by income, wealth,

and product prices.
Diff: 1 Skill: Definition Topic: budget constraint

AACSB:
12. Assume you have an income of $200 and you can only purchase two goods – good A and
good B. If the price of good A and B are $1 and $2 how much of each good can
purchase? Assume that the price of good A falls why would you now consider not only

consuming more of good A but also more of good B? What’s going on that might cause
this behavioral response?
You can purchase 200 units of good A and 100 units of good B. If the price of good
A fell you not only would be interested in buying more of good A but you may also
wish to purchase more of good B as well since you now have more real income
because of good A’s price decline.
Diff: 1 Skill: Definition Topic: substitution and income effect

AACSB: Analytic Skills
13. What is a household’s choice set or opportunity set?
A choice set is the set of options that is defined and limited by a budget constraint.
Diff: 1 Skill: Definition Topic: choice set

AACSB:

14. Use the budget constraint below to identify economic meaning of each of the choice
points: A, B, C, D, and E.
Points A, B and C exhaust all the consumer’s income. Point D involves saving and
point E is simply not attainable given current prices and income.

AACSB:

15. Susie receives an allowance from her parents of $10 per week. She spends her entire
allowance on two goods: cans of hairspray and bubble gum. The price of a can of
hairspray is $2 and the price of a pack of bubble gum is $1. Draw Susie's budget
constraint.
The budget constraint is drawn below.
Diff: 1 Skill: Conceptual Topic: budget constraint

AACSB:
16. Susie receives an allowance from her parents of $10 per week. She spends her entire
allowance on two goods: cans of hairspray and bubble gum. The price of a can of
hairspray is $2 and the price of a pack of bubble gum is $1. What is the opportunity cost
of a can of hairspray? What is the opportunity cost of a pack of bubble gum?
The opportunity cost of a can of hairspray is 2 packs of bubble gum. The

opportunity cost of a pack of bubble gum is 1/2 can of hairspray.
Diff: 1 Skill: Analytic Topic: opportunity cost


17. Mike is a college student who works part time and earns $100 per week. He spends his
entire income on two goods: pepperoni pizzas and bottles of soda. The price of a
pepperoni pizza is $10 and the price of a bottle of soda is $2. Draw Mike's budget
constraint.
The budget constraint is drawn below.
Diff: 1 Skill: Conceptual Topic: budget constraint

AACSB:
18. Mike is a college student who works part time and earns $100 per week. He spends his
entire income on two goods: pepperoni pizzas and bottles of soda. The price of a
pepperoni pizza is $10 and the price of a bottle of soda is $2. What is the opportunity
cost of a pepperoni pizza? What is the opportunity cost of a bottle of soda?
The opportunity cost of a pepperoni pizza is 5 bottles of soda. The opportunity cost
of a bottle of soda is 1/5 of a pepperoni pizza.
Diff: 1 Skill: Analytic Topic: opportunity cost

Scenario 1

Let’s say that you only have enough time to take two college courses in a semester. You also
only have 15 hours per week to devote to both courses – French and Economics. Assume that
you could earn a “70” in both courses even if you didn’t study at all for either course. If you
study for either course your productivity is such that each hour spent studying for a course
earns you 2 points for your grade in that course.
19. Using Scenario 1 what is the maximum grade you could earn in any one course? If you
wanted to earn a grade of 90 in French but no better than a 70 in economics are you
operating on your budget constraint? Why or why not?
The maximum grade you could earn in either course is a 100. Fifteen hours times 2
points is 30 points plus the original 70 that you were going to get without studying.
If you only care about making a 90 in French and no better than a 70 in economics
then you are not operating on the budget constraint. Why? It would only require 10
hours of your time to earn the 90. You would have 5 hours left over.
Diff: 1 Skill: Analytic Topic: budget constraint

20. Using Scenario 1 what would happen to your budget constraint if you came up with a
study technique that allowed you to earn 3 points for every hour spent studying
economics and still only 2 points for every hour spent studying French? What has
happened to the relative price of one hour of studying French?
The budget constraint would pivot out. The relative price of studying French would
actually rise since every hour you spend studying French is costing your 3 points
towards your economics grade rather than the previous 2 points.

21. Using Scenario 1 what would happen to your budget constraint if suddenly you
discovered an extra 10 hours in your schedule that you could use to study. What would
happen to the slope of the budget constraint? What would happen to the positioning of
the budget constraint?
The slope of the budget constraint would remain unchanged. However the budget
constraint would shift outward and to the right.

AACSB:

22. Lance earns $500 per week. He spends his entire income on two goods: movies and
bottles of wine. The price of a movie is $10 and the price of a bottle of wine is $10.
Draw Lance's budget constraint and identify his opportunity set.
The budget constraint is drawn below. The opportunity set is the area on and inside
the triangle.
Diff: 1 Skill: Analytic Topic: opportunity set

AACSB:
23. Lisa has an income of $250 per week, which she spends entirely on milk and eggs. The
price of milk is $2 per gallon and the price of a dozen eggs is $1. What is the opportunity
cost of a gallon of milk? If the price of a dozen eggs rises to $1.50, what happens to the
opportunity cost of a gallon of milk?
The opportunity cost of a gallon of milk is 2 dozen eggs. If the price of eggs rises to
$1.50 per dozen, the opportunity cost of a gallon of milk falls to 1.33 dozen eggs.

AACSB:
24. Misty spends her entire weekly allowance of $15 on two goods: T-shirts (which cost $10
each) and lipstick (which costs $5). What is the opportunity cost of a T-shirt? If her
parents raise her allowance to $20 per week, what happens to the opportunity cost of a T-
shirt?
The opportunity cost of a T-shirt is 2 lipsticks. If her parents change her allowance,
the opportunity cost of a T-shirt is unaffected.
AACSB:

25. Justin has a part-time job and earns $50 per week. He spends his entire income on two
goods: Hamburgers (which cost $2 each) and movie rentals (which cost $3 each). Draw
Justin's budget constraint. Suppose that Justin decides to purchase 10 hamburgers and
rent 10 movies this week. Is this choice within Justin's opportunity set? Show this
choice on your graph.
Yes, Justin is able to purchase 10 hamburgers and rent 10 movies. That is one
point on his budget constraint.
Diff: 1 Skill: Analytic Topic budget constraint

AACSB:

26. Joseph earns $200 per week and spends his entire income on cheese (which costs $5 per
pound) and crackers (which cost $2 per box). Draw Joseph's budget constraint. If the
price of cheese increases to $8 per pound, what will happen to Joseph's budget
constraint?
After the price of cheese rises, the budget constraint will tilt down and become
flatter.
Cheese
40
25
100 Crackers

AACSB:

27. Connor receives a weekly allowance of $20 from his parents that he uses to purchase two
goods: Pokemon cards (which cost $5 per pack) and comic books (which cost $4 each).
Draw Connor’s budget constraint. Show what would happen if Connor’s parents lower
his allowance to $15 per week. Does the opportunity cost of a comic book change?
The budget constraints are shown below. When Connor’s allowance falls, the
budget constraint shifts in but keeps the same slope. The opportunity cost of a comic
book is unaffected. It is equal to 4/5 of a pack of Pokemon cards both before and
after the change in Connor’s allowance.
Pokemon
cards (packs)
3.75 5 Comic books

AACSB:
Scenario 2
Assume that a poor person has an income of $500. There are only two goods that he can
consume – food and “all other goods”. Food prices are $2 and “all other goods” are $1.
Assume that the government is considering two possible way to help this person. Plan A
involves providing $100 in cash. Plan B involves providing $100 in food coupons that can
only be spent on food.
28. What happens to the budget constraint of the recipient when he receives the $100 cash
under Plan A? What is likely to happen to his consumption of both food and “all other
goods” if they are both normal goods?
The budget constraint will shift out and to the right under the cash plan. His
consumption of both goods are likely to rise if they are normal goods.


29. What happens to the maximum amount of “all other goods” that this person can buy if
instead he receives the $100 in food coupons? What’s the maximum amount of food he
can buy under this plan?
He still can only purchase 500 units of “all other goods”. The maximum amount of
food is 300 units.

AACSB:
30. Heather earns $100 per week that she uses to purchase two goods: trips to a day spa
(which cost $100 each) and shoes (which cost $50 per pair). Draw Heather’s budget
constraint. Show what would happen if Heather receives a raise and begins earning $200
per week. If trips to the day spa and shoes are both normal goods, what will happen to
the amount of spa trips and pairs of shoes that Heather buys?
The budget constraints are shown below. When Heather’s income rises, the budget
constraint shifts out but keeps the same slope. Since trips to the day spa and shoes
are both normal goods, Heather will purchase more of each of them.
Trips to Day
Spa
2 4
pairs of shoes


31. Graph the budget constraint for Px = 2, Py =4, and I = 1000. What is the slope of the
budget constraint? Measure units of X along the horizontal axis and units of Y along the
vertical axis. Answer:

AACSB:
32. Graph the budget constraint for Px = 2, Py = 3, and I = 1000. What is the slope of the
budget constraint? Measure units of X along the horizontal axis and units of Y along the
vertical axis. Answer:

AACSB:

33. Sketch the budget constraint under the condition that Py = 3, Px = 4 for the first 100 units
and Px = 2 for all units purchased greater than 100. Assume I = 1000. Graph the effect of
a reduction in the price of Y to 2.

AACSB:
34. Sketch the budget constraint under the condition that Py = 3, Px = 4 for the first 100 units
and Px = 2 for all units purchased greater than 100. Assume I = 1000. Graph the effect of
income rising to 1500. Answer:

AACSB:

35. Assume that income in year 1 is 1000 and 1200 in year 2 and the individual can against
his future income or lend his current income at zero cost. Graph the budget constraint.
Measure consumption in year 1 along the horizontal axis and consumption in year 2
along the vertical axis. Answer:

AACSB:
Refer to the information provided in Scenario 3 below to answer the following questions.
SCENARIO 3: Consider the budget allocation decision of a family of four on vacation in a

beach resort. The family has $300 budgeted for entertainment for the weekend and two
options: Renting bicycles for $10 an hour per bicycle or playing miniature golf for $4 a game
per person. Consider each question separately, and place golfing on the vertical axis and
bicycling on the horizontal axis. Assume that all four family members must do everything
together.
36. Refer to Scenario 3. Graph the budget constraint.

AACSB:

37. Refer to Scenario 3. Graph the effect of a "Rent 3 Get 1 Bicycle Free" promotion.

AACSB:
38. Refer to Scenario 3. Graph the effect of a 100% increase in the price of miniature golf.

AACSB:

39. Refer to Scenario 3. Graph the effect of a promotion of two free hours of bicycling for
each family of four. Answer:

AACSB:
40. Graph the budget constraint for Px = 2, Py = 3, and I = 1500. Measure units of X along
the horizontal axis and units of Y along the vertical axis. Answer:

AACSB:

41. Graph the budget constraint for Px = 2, Py = 3, and I = 1500 with the additional
condition that X is free for the first 250 units. Measure units of X along the horizontal axis
and units of Y along the vertical axis. Answer:
This graph indicates that the consumer may consume up to 250 units of X for free
while spending his/her income entirely on good Y.

AACSB:
42. Graph the budget constraint for a worker who earns 5 dollars an hour and can,
theoretically, work 24 hours a day. Measure units of leisure along the horizontal axis.
Now graph the budget constraint for a worker who makes 6 dollars an hour and can,
theoretically, work 24 hours a day. Compare the two graphs. Answer:
The budget constraint pivots when the wage increases. The slope increases to reflect
the fact that the opportunity cost of leisure has increased.

AACSB:

43. Assume that Paula can buy gum or candy. A pack of gum costs $.30 and a candy bar
costs $.50. Paula has $3.00 a day to spend on gum and candy bars. Draw Paula's budget
constraint. Shade in Paula's choice set. On the graph show how Paula's budget constraint
will be affected if the price of gum increases to $.50. Answer:
The budget constraint will intersect the gum axis at 10 and the candy axis at 6.
The area to the left of the budget constraint is the consumer's choice set. If the
price of gum increases to $.50, the budget constraint will now intersect the gum
axis at 6.

AACSB:
44. What is a household's choice set defined as?
Choice set is defined as the set of options that is characterized and limited by the
budget constraint.

AACSB:
45. Tony spends $36 per month on cookies. For him, chocolate chip cookies and peanut
butter cookies are perfect substitutes. Chocolate chip cookies are $4 per dozen and peanut
butter cookies are $3 per dozen. How many dozen of each type of cookie will Tony buy
in a given month if he wants to maximize his utility?
Tony will by no chocolate chip cookies and 12 dozen peanut butter cookies.
Diff: 2 Skill: Analytic Topic: perfect substitutes

AACSB:

THE BASIS OF CHOICE: UTILITY
46. What is meant by utility?
Utility is the satisfaction (or reward) a product yields relative to its alternatives. It
is the basis of choice.
Diff: 1 Skill: Definition Topic: utility

AACSB:
47. What problems are implicit in the concept of utility?
(1.) It is impossible to measure utility.

(2.) It is impossible to compare the utility of different people.
Diff: 1 Skill: Conceptual Topic: utility

AACSB:
48. What is the difference between total utility and marginal utility?
Total utility is the total amount of satisfaction obtained from the consumption of a
good or a service. Marginal utility is the additional satisfaction gained by the
consumption of one more unit of a good or service.

AACSB:

49. Below represents a total utility function for someone that goes to the gym. Add a second
column in which you calculate the marginal utility of each visit to the gym. Use this
information to determine when diminishing marginal utility sets in.
Diminishing marginal utility sets in with the second trip to the gym.

AACSB:
50. Explain how it is possible for marginal utility to fall while total utility is still on the rise?
Total utility is the sum of the marginal utilities of all previous units. Even if
marginal utility is falling as long as it is still positive that will allow total utility to
continue to rise.
Diff: 1 Skill: Conceptual Topic: marginal utility

AACSB:

51. When total utility is rising but at a decreasing rate what must be happening to marginal
utility? When will total utility stop rising?
Marginal utility is still positive but it is becoming smaller. Total utility will stop
rising when marginal utility reaches zero.
Diff: 2 Skill: Conceptual Topic: marginal and total utility

AACSB:
52. When total utility is at its maximum what must be the value of marginal utility?
Total utility is maximized when marginal utility is zero.

AACSB:

53. Use the total utility function below to construct a marginal utility function.

AACSB:

54. Observe the difference in vending machines between canned soda and newspapers.
Typically, if you insert coins into a newspaper vending machine and open it you will see
available all of the copies of the newspaper within one’s reach. However, soda machines
are very different. They work such that only one can is dispensed at a time. The rest of
the canned soda is well out of reach. Explain in terms of marginal utility why the
newspaper distributor is relatively unconcerned about the rest of the newspapers being
taken without payment while the soda distributor uses a machine that goes to great
lengths to insure that only one can of soda is dispensed at a time.
The answer is fairly straightforward. A second or third newspaper probably has

close to a zero marginal utility for the typical consumer. The second copy doesn’t
really provide him with any net gain in satisfaction. However, the rest of the canned
soda in all likelihood would still have a positive marginal utility for most consumers.
Therefore, it is worth it to spend a little extra money on a machine that keeps the
rest of the product away from prying hands. By contrast, the low incidence of theft
of newspapers provides no justification for a more complex vending machine.
Diff: 3 Skill: Conceptual Topic: diminishing marginal utility

55. What is the law of diminishing marginal utility?
The law of diminishing marginal utility states that the more of any one good
consumed in a given period the less satisfaction generated by consuming each
additional unit of the good.
Diff: 1 Skill: Definition Topic: law of diminishing marginal utility

AACSB:
56. Using the consumer equilibrium condition which is expressed in algebraic form below
prove that this is the same thing as saying that consumer equilibrium occurs when the
ration of the marginal utilities per dollar are equal for both goods.
Answer: By multiplying both sides of this equation by MUY and dividing both sides
by PX, we can rewrite this utility-maximizing rule as follows:
Diff: 2 Skill: Analytic Topic: utility-maximizing rule

AACSB:

57. Evaluate the following statement. “As long as I am still enjoying this candy I am going to
keep buying and eating more of it”.
This confuses marginal and total utility. While it might be true that he is still
receiving positive marginal utility from eating more of the candy it might not be the
most rational thing for him to do in order to maximize his total utility. That is, he
might be better off redirecting some of this expenditures toward another good that
has a higher marginal utility per dollar.

58. Comment on the following statement: “Diminishing marginal utility means that total
utility falls when an additional unit of a good is consumed.”
That statement is not true. Diminishing marginal utility means that marginal utility
falls when an additional unit of a good is consumed.
Diff: 1 Skill: Conceptual Topic: law of diminishing marginal utility

AACSB:

59. The table below shows how the total utility that Zach derives from eating candy bars
changes as he consumes more and more candy bars each day:
Candy Bars Total Utility Marginal Utility

1 20
2 30
3 38
4 44
5 48
6 50
Fill in the table above. Do the numbers in the table support the law of diminishing
marginal utility? Explain.
Yes, the numbers in the table show diminishing marginal utility. Marginal
utility falls as each additional candy bar is consumed.
Candy Bars Total Utility Marginal Utility

1 20 20
2 30 10
3 38 8
4 44 6
5 48 4
6 50 2
Diff: 1 Skill: Analytic Topic: diminishing marginal utility

AACSB:

60. Kylie spends her income of $150 per week on two goods: movies (which cost $5 each)
and books (which cost $10 each). At her current level of consumption, the marginal
utility from the last movie consumed is 20 and the marginal utility from the last book
consumed is 30. Is Kylie maximizing her utility? Why or why not? If not, what should
Kylie do to achieve a higher level of utility?
No, she is not maximizing utility. She should be consuming such that the marginal
utility per dollar spent on movies is equal to the marginal utility per dollar spent on
books. In this case, the marginal utility per dollar spent on movies is higher.
Therefore, she should increase her consumption of movies and lower her
consumption of books.
Diff: 2 Skill: Analytic Topic: utility maximization

61. The table below shows how the total utility that Alan derives from watching basketball
games changes as he watches more and more games each week:
Basketball Games Total Utility Marginal Utility

1 55
2 85
3 110
4 130
5 145
6 155
Fill in the table above. Do the numbers in the table support the law of diminishing
marginal utility? Explain.
Yes, the numbers in the table show diminishing marginal utility. Marginal utility
falls as each additional basketball game is watched.
Basketball Games Total Utility Marginal Utility
1 55 55
2 85 30
3 110 25
4 130 20
5 145 15
6 155 10
Diff: 1 Skill: Analytic Topic: diminishing marginal utility
AACSB:

62. Colin spends his income of $100 per week on two goods: pizzas (which cost $8 each) and
milk (which costs $1 per gallon). At his current level of consumption, the marginal
utility from the last pizza consumed is 32 and the marginal utility from the last gallon of
milk is 4. Is Colin maximizing his utility? Why or why not? If not, what should Colin
do to achieve a higher level of utility?
Yes, he is maximizing utility. He is consuming such that the marginal utility per
dollar spent on pizza is equal to the marginal utility per dollar spent on milk.

63. What is the utility-maximizing rule?
A consumer is maximizing utility when the marginal utility derived from the last
unit of good X consumed divided by the price of good X is equal to the marginal
utility derived from the last unit of good Y consumed divided by the price of good Y.
Diff: 1 Skill: Definition Topic: utility maximization

AACSB:
64. What is the diamond-water paradox?
The diamond-water paradox is a paradox stating that (1) the things with the
greatest value in use frequently have little or no value in exchange, and (2) the
things with the greatest value in exchange often have little or no value in use.
Diff: 1 Skill: Definition Topic: consumer surplus

AACSB:
65. What does diminishing marginal utility imply about the shape of a person’s demand
curve? Explain.
Demand curves will be downward sloping because of the law of diminishing

marginal utility. Individuals will compare the value of the marginal utility they
receive from a good with its price: if the value of the good is higher or equal to the
price, the individual will purchase it. Thus, a person will buy more of a good at a
low price than at a high price.
Diff: 1 Skill: Conceptual Topic: diminishing marginal utility

AACSB:

INCOME AND SUBSTITUTION EFFECTS
66. Suppose that Jeanna's income rises. If tomatoes are a normal good, what will happen to
the quantity of tomatoes purchased by Jeanna? Is this an income effect, a substitution
effect, or both? Explain.
Jeanna will purchase more tomatoes if her income rises because tomatoes are a
normal good. This is an income effect. Her income has increased, so she is better
off. There is no substitution effect in this case because there is no change in relative
prices.
Diff: 2 Skill: Analytic Topic: income and substitution effects

AACSB:
67. When the price of corn increases, the quantity of corn demanded falls. Explain this
change in terms of income and substitution effects.
When the price of corn rises, households have less purchasing power than before. If
corn is a normal good, this means that they will consume less of it. This is the
income effect. Also, an increase in the price of corn makes corn relatively more
expensive. Thus, households will shift away from purchasing corn to purchase
relatively cheaper goods. This is the substitution effect. Both effects imply that the
quantity of corn demanded will fall as the price of corn rises.

AACSB: Reflective Thinking
68. When the price of raisins falls, the quantity of raisins demanded rises. Explain this
change in terms of income and substitution effects.
When the price of raisins falls, households have more purchasing power than
before. If raisins are a normal good, this means that they will consume more of
them. This is the income effect. Also, a decrease in the price of raisins makes
raisins relatively less expensive. Thus, households will shift toward purchasing
raisins from purchasing relatively more expensive goods. This is the substitution
effect. Both effects imply that the quantity of raisins demanded will rise as the price
of raisins falls.

AACSB:

69. Suppose that macaroni and cheese is an inferior good and the price of macaroni and
cheese rises. Explain the income and substitution effects of this price change.
When the price of macaroni and cheese rises, we have less purchasing power than
before. If macaroni and cheese is an inferior good, this means that we will consume
more of it. This is the income effect. Also, an increase in the price of macaroni and
cheese makes it relatively more expensive. Thus, households will shift away from
purchasing macaroni and cheese to purchase relatively cheaper goods. This is the
substitution effect. Because these two effects work in opposite directions, the
outcome (in terms of the quantity of macaroni and cheese demanded) will depend on
which effect is larger. While it is theoretically possible, it is unlikely for this income
effect to be larger than the substitution effect.

70. Differentiate between an income effect and a substitution effect.
Ceteris paribus, the income effect of a price decrease increases the opportunity to
buy more of all goods, whereas the substitution effect of a price decrease makes the
good become relatively cheaper. In the case of a price increase, the income effect
reduces the opportunity to buy all goods, whereas the substitution effect makes the
good become relatively more expensive.
Diff: 3 Skill: Conceptual Topic: income and substitution effects

AACSB:
71. For a normal good, the income and substitution effect work in the same direction. For an
inferior good, the income and substitution effects work in opposite directions. Does this
imply that the demand curve for an inferior good is upward sloping? Explain.
No. As long as the income effect is smaller than the substitution effect the demand
curve will still be downward sloping.
Diff:3 Skill: Conceptual Topic: income and substitution effects

AACSB:

72. During the mid 1980s the price of gasoline fell. Americans purchased not only more
gasoline but other goods as well. Use consumer theory to explain why this happened.
Essentially two effects are unleashed at the same time. The substitution effect
induces people to consume more of the good whose relative price fell and the income
effect from the lower-priced gasoline induces people to consumer more of all goods
including gasoline.

AACSB:
73. Using the concept of income and substitution effects, explain how you might react to
each of the following:
(a) You currently work 20 hours a week at $10 per hour and your employer tells you he
must reduce your wage to $8 per hour.
(b) The price of pizza doubles and the price of hamburgers remains constant.
(a) A reduction in the wage rate could either cause hours worked to increase or
decrease, depending on whether the income or substitution effect is stronger.
(b) If the price of pizza doubles, the consumer's real income decreases, so the
consumer would eat less pizza. Because the price of hamburgers remains constant,
the consumer will substitute hamburgers for pizza

AACSB:
74. Explain the income and substitution effects of an increase in the interest rate on savings.
If the interest rate rises, the substitution effect will lead to an increase in saving
because the relative cost of current consumption increases. The income effect will
cause a decrease in saving because it will require less saving today to reach the
target consumption level in the future. Therefore, the effect of an increase in the
interest rate on saving is indeterminate.

AACSB:

75. Assume a distant tribe only harvests breadfruit and its entire livelihood depends on it. If
the price of breadfruit were to rise suddenly how might it be possible that this tribe would
actually consume more breadfruit?
The substitution effect would cause a decline in the consumption of bread fruit
ceteris paribus. However, because breadfruit is the principle means by which the
tribe earns its income there is also an income effect. If breadfruit is a normal good
and the income effect is strong enough it can outweigh the substitution effect.

AACSB:
76. In the 1970s there was a long draught in California that left a large section of Southern
California parched. As water prices began to soar how do you think most residents
changed their consumption of water? What kinds of water consumption probably did not
change and why? Make sure to use utility in your explanation.
Most people probably either eliminated or reduced drastically the washing of cars,
the watering of lawns and maybe even the filling of swimming pools. But the
drought probably did not have much of an impact on internal consumption, bathing
or the brushing of teeth. The items that were curtailed were no doubt those that
provided the least amount of marginal utility.
Diff: 1 Skill: Definition Topic: consumer surplus

77. Explain the income effect and the substitution effect due to an increase in the wage rate.
An increase in income will lead to a higher demand for leisure. However, an

increase in the wage rate will also make leisure more expensive. Since these two
effects are moving in opposite directions of one another theory alone cannot tell us
the net effect without knowing the absolute change of the income and substitution
effects.

78. Explain the income effect and the substitution effects of a price change for a normal
good.
For normal goods, the income and substitution effects work in the same direction.
Higher prices lead to a lower quantity demanded, and lower prices lead to a higher
quantity demanded.


HOUSEHOLD CHOICE IN INPUT MARKETS
79. List the three decisions that households face in the labor market.
(1.) Whether to work.

(2.) How much to work.
(3.) What kind of a job to choose.
Diff: 1 Skill: Fact Topic: labor market determinants

AACSB:
80. Identify three things which affect the choices households make with respect to how much
labor to supply?
The decision of how much labor to supply is affected by three things: the availability
of jobs, market wage rates, and the skills possessed by members of the household.
Diff: 1 Skill: Conceptual Topic: labor market determinants

AACSB:
81. How would you measure the price of an hour of leisure? Explain.
The price of an hour of leisure can be measured by the hourly wage. The
opportunity cost of enjoying an hour of leisure is the amount of foregone income
that could have been earned at a job.
Diff: 1 Skill: Conceptual Topic: price of leisure

AACSB:
82. Assume the government reduces your welfare check by $1 for every $2 that you earn on
the job while on welfare. How will this tax affect your labor supply decisions? What is
the implicit tax rate of such a policy?
The higher tax lowers the effective wage. The lower wage reduces the opportunity
cost of leisure and discourages work. The implicit tax rate is 50%.
Diff: 1 Skill: Conceptual Topic: labor supply

AACSB:
83. What does a labor supply curve represent? What does it look like?
A labor supply curve is a diagram that shows the quantity of labor supplied at
different wage rates. Its shape depends on how households react to changes in the
wage rate. It will typically slope upwards as long as the substitution effect

dominates. However, there is a possibility that the labor supply curve could bend
backwards at higher wages if the income effect dominates the substitution effect.
Diff: 1 Skill: Definition Topic: labor supply

AACSB:
84. Tyler's wage rises and he chooses to increase the number of hours he supplies to the labor
market. What does this imply about the relative sizes of the substitution effect and the
income effect? Explain.
This must mean that the substitution effect outweighs the income effect. The
substitution effect of a wage increase implies that leisure is more expensive and the
individual will work more. The income effect suggests that since the worker is
better off (and leisure is a normal good), the worker will work less. Since Tyler
chooses to work more, the substitution effect must be larger.
Diff: 2 Skill: Analytic Topic: labor supply

85. Refer to the figure below. What can we say about the relative sizes of the income and
substitution effects?
Wage
Supply
Quantity of labor
Because an increase in the wage leads to a decrease in the quantity of labor supplied,
we can tell that the income effect is larger than the substitution effect.

AACSB:
86. Comment on the following statement: "An increase in the wage always leads to an
increase in the quantity of labor supplied."
The statement is false. If the substitution effect is larger than the income effect, a
wage increase will lead to an increase in the quantity of labor supplied. However, if

the income effect is larger, an increase in the wage will actually lead to a decline in
the quantity of labor supplied.

AACSB:
87. What is the financial capital market?
The financial capital market is the complex set of institutions in which suppliers of
capital (households that save) and the demand for capital (business firms wanting to
invest) interact.
Diff: 1 Skill: Definition Topic: financial market

AACSB:
88. Explain how income and substitution effects alter the saving behavior of households.
When the interest rate rises, the opportunity cost of spending income rises and
therefore, individuals will be more likely to save. This is the substitution effect.
However, because the interest rate increase makes households better off, they want
to purchase more normal goods and save less. This is the income effect.
Diff: 2 Skill: Analytic Topic: saving

AACSB:
89. Empirical evidence suggests that saving tends to rise when there is an increase in interest
rates. What does this imply about the relative sizes of the income and substitution
effects? Explain.
The substitution effect must be larger. The substitution effect of an interest rate
increase suggests that households will save more because the opportunity cost of
spending has increased. The income effect suggests that an increase in the interest
rate makes households better off and therefore they will want to spend more.
Because saving rises when the interest rate increases, the substitution effect must be
larger.
Diff: 2 Skill: Analytic Topic: saving

AACSB:
APPENDIX: INDIFFERENCE CURVES
90. Explain the four assumptions on which the theory of consumer choice is based. Select
one of these assumptions and explain what would happen if this assumption did not hold
true.

It is assumed that more is better. If more is not always better, the indifference
curves would eventually have a positive slope. A diminishing marginal rate of
substitution is assumed. If this assumption did not hold true, indifference curves
would not be convex to the origin. Consumers can rank bundles so that they identify
one bundle as being preferred to another or that they are indifferent between
bundles. The last assumption is one of rationality. If consumers could not rank
bundles or if consumers were not rational, it would be impossible to identify the
point of utility maximization.
Diff: 2 Skill: Definition Topic: consumer choice

AACSB:
91. What is an indifference curve?
An indifference curve is a set of points, each representing a combination of goods

that yield the same total utility.
Diff: 1 Skill: Definition Topic: indifference curve

AACSB:
92. Why are indifference curves convex to the origin?
Indifference curves are convex because of diminishing marginal utility. When a

consumer has a large amount of good Y (and a small amount of good X), he will be
willing to give up a great deal of good Y to receive a little more of good X. However,
if the individual has only a small amount of good Y and a large amount of good X,
he will not be very willing to give up good Y to receive more of good X.
Diff: 2 Skill: Conceptual Topic: indifference curve

AACSB:
93. Assume the properties of normal indifference curves. Where will a consumer maximize
their utility?
The consumer will maximize their utility where the indifference curve is just
tangent to the budget constraint.
Diff: 2 Skill: Definition Topic: utility maximization

AACSB:
94. If a consumer has a choice between only two goods and both of them are perfect
substitutes what would the indifference curve look like and why?
The indifference curves would be downward-sloping and linear since the consumer
would be willing to trade them at a fixed ratio.

Diff: 2 Skill: Definition Topic: indifference curves

AACSB:
95. If a consumer has a choice between only two goods and both of them are perfect
complements what would the indifference curve look like and why?
The indifference curves would be “L-shaped”. The reasoning is that one good must
be accompanied by the other good in order to give the first any utility. Having more
of the second good however, doesn’t make the person any better off.

AACSB:
96. How can a consumer's demand for a good be derived using indifference curve analysis?
As the price of a good changes the consumer's budget constraint changes. Thus, it is
possible to see how the consumer changes his utility-maximizing choice. This will
give us his new quantity demanded at each price.
Diff: 2 Skill: Analytic Topic: indifference curves

AACSB:
97. If an indifference curve were concave instead of convex to the origin, what implication
would that have if the consumer reduces consumption of one good but still wants to enjoy
the same level of utility in a two-good world?
Essentially it would mean that the consumer would not need as much of the second
good to compensate him for his reduction in the consumption of the first good.

AACSB:
98. Using indifference curves and budget constraints, explain how a consumer maximizes
utility. Show how this analysis can be used to derive a demand curve for a good. Answer:

The students need to identify utility maximization as the point of tangency between
the budget constraint and the indifference curve. To derive demand they need to
vary the price of X and show how consumption of X will change.

AACSB:
99. Illustrate with a diagram a consumer in equilibrium with indifference curves and a budget
constraint. Measure units of X on the horizontal axis and units of Y on the vertical axis.
Provide intuitive and mathematical explanations for what must be true in equilibrium.
Answer:

When utility is maximized the willingness of the individual to trade one good for the
other (slope of the indifference curve) is equal to the relative value of the goods
(price ratio, or the slope of the budget constraint) in the market or
MUY/MUX=PY/PX.

AACSB:
100. Explain the assumption of free disposal as it applies to indifference curve analysis.
In indifference curve analysis we are restricted to goods that yield positive marginal
utility, or,more simply, that “more is better.” One way to justify this assumption is
to say that when more of something makes you worse off, you can simply throw it
away at no cost.

AACSB:

101. Graphically illustrate the effect of an increase in income on the budget constraint.
Assuming that both X and Y are normal goods, graphically illustrate how equilibrium
consumption will change with an increase in income.
Diff: 2 Skill: Analytic Topic: budget constraint shift

AACSB:
102. Using the graph below explain why a consumer would not wish to consume at either

points A or C even though he could afford to do so.

\
Graphically, the consumer will move along the budget constraint until the highest
possible indifference curve is reached. At that point, the budget constraint and the
indifference curve are tangent. This point of tangency occurs at X* and Y* (point
B). Even though points A and C are possible for the consumer they don’t yield the
highest possible level of utility that could be attained.
Diff: 2 Skill: Analytic Topic: budget constraint shift

AACSB:

Principles of Microeconomics 12th Edition Case Test Bank Download

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Principles of Microeconomics 12th Edition Case Test Bank Download

Uploaded by

Copyright:

Available Formats

Principles of Microeconomics 12th

Edition Case Test Bank

Test Bank: https://testbankpack.com/p/test-bank-for-principles-

Solution Manual: https://testbankpack.com/p/solution-manual-

Diff: 1 Skill: Conceptual Topic: households

Diff: 1 Skill: Conceptual Topic: firms

3. What does the assumption of perfect knowledge include?

Diff: 1 Skill: Conceptual Topic: perfect knowledge

4. List the characteristics of a perfectly competitive market.

Diff: 1 Skill: Definition Topic: perfectly competitive market

5. What is meant by the term homogeneous products? Give an example.

Homogeneous products are products that are identical to or indistinguishable from

Diff: 1 Skill: Definition Topic: homogeneous product

Diff: 1 Skill: Definition Topic: homogeneous product

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Conceptual Topic: perfectly competitive markets

Copyright © 2017 Pearson Education, Inc.

(1.) How much of each product to demand.

Diff: 1 Skill: Conceptual Topic: households

Diff: 1 Skill: Definition Topic: homogeneous product

(1.) The price of the product.

Diff: 1 Skill: Conceptual Topic: determinants of demand

11. What is a budget constraint?

A budget constraint is the limit imposed on household choices by income, wealth,

Diff: 1 Skill: Definition Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Definition Topic: substitution and income effect

13. What is a household’s choice set or opportunity set?

Diff: 1 Skill: Definition Topic: choice set

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Definition Topic: choice set

Copyright © 2017 Pearson Education, Inc.

The budget constraint is drawn below.

Diff: 1 Skill: Conceptual Topic: budget constraint

The opportunity cost of a can of hairspray is 2 packs of bubble gum. The

Diff: 1 Skill: Analytic Topic: opportunity cost

Copyright © 2017 Pearson Education, Inc.

The budget constraint is drawn below.

Diff: 1 Skill: Conceptual Topic: budget constraint

Diff: 1 Skill: Analytic Topic: opportunity cost

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Analytic Topic: budget constraint

Diff: 1 Skill: Analytic Topic: budget constraint

Diff: 1 Skill: Analytic Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Analytic Topic: opportunity set

Diff: 1 Skill: Analytic Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Analytic Topic budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Analytic Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

3.75 5 Comic books

Diff: 1 Skill: Analytic Topic: budget constraint

Diff: 1 Skill: Analytic Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 1 Skill: Analytic Topic: budget constraint

Diff: 1 Skill: Analytic Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 2 Skill: Analytic Topic: budget constraint

Diff: 2 Skill: Analytic Topic: budget constraint

Copyright © 2017 Pearson Education, Inc.

Diff: 2 Skill: Analytic Topic: budget constraint

Diff: 2 Skill: Analytic Topic: budget constraint