Consumer Behavior:

1)
Questions
Q3 How can time be incorporated into the theory of consumer behavior? Explain the following
comment: “Want to make millions of dollars? Devise a product that saves Americans lots of time.”
LO2

Answer: Time is money. This expression is a time-saving way of making the point
that for a person who can make so much per hour, every hour spent not working is so much
money not made. A person can be said to “consume” a ball game or an evening at the
theater. If the ball game costs $10 and the theater $20, at first sight one could say the ball
game is a better deal. But if the person makes $20 an hour and is forgoing this in taking the
time off, then we must take into account the time spent at the ball game and at the theater. If
the ball game goes into extra innings and takes 4 hours, then its total cost is $90 (= $10 +
$80). If the theater takes 3 hours, its total cost is $80 (= $20 + $60). Assuming the marginal
utility of the ball game and attending the theater are the same, the theory of consumer
behavior (with time taken into account) would therefore have this consumer going to the
theater.

4. Explain: LO2
a. Before economic growth, there were too few goods; after growth, there is too little time.
b. It is irrational for an individual to take the time to be completely rational in economic decision
making.
c. Telling your spouse where you would like to go out to eat for your birthday makes sense in terms of
utility maximization.

Answer:
(a) Before economic growth, most people lived at the subsistence level. By practically
anyone’s definition, this implies “too few goods.” After economic growth, goods are in
relative abundance. To make (or consume) more takes time, but the relative abundance of
goods means that there are already many goods to enjoy. So, now there is a clash between
the use of time to make more goods and the use of time to relax and enjoy the goods one
already has. There just isn’t enough time.
(b) To be completely rational in economic decision making, provided one does not take
time into consideration, one has to take account of every factor. This would take a great deal
of time. One could not, for example, make any purchase without first searching the
classifieds to see whether a better deal could be had, rather than simply heading for the
nearest store. However, this would be most irrational, for time does have value. While
making an extensive search before making any deal, one would be forgoing the income to
make this or any deal. For every penny saved to make the perfect deal, one would be losing
dollars in income because of the time spent in making the perfect deal.
(c) There is little time sacrificed in making a request to your spouse for the restaurant
where you eat on your birthday. If you eat there, the benefit will likely exceed the cost. It
also reduces the probability of eating at a restaurant where the market value (purchase price)
exceeds the utility to the recipient.
 Problems:
4. Columns 1 through 4 in the table below show the marginal utility, measured in utils, that Ricardo
would get by purchasing various amounts of products A, B, C, and D. Column 5 shows the marginal
utility Ricardo gets from saving. Assume that the prices of A, B, C, and D are, respectively, $18, $6,
$4, and $24 and that Ricardo has an income of $106. LO2

a. What quantities of A, B, C, and D will Ricardo purchase in maximizing his utility?

b. How many dollars will Ricardo choose to save?
c. Check your answers by substituting them into the algebraic statement of the utility-maximizing rule
(verify that all of the income has been exhausted between the various goods and savings).

Answer: (a) 4 units of good A, 3 units of good B, 3 units of good C, zero units of good D; (b) $4;
(c) $106 (= $18x4 + $6x3 +$4x3 + $24x0 + $4)

Feedback: Consider the following information and use the table above: the prices of A, B, C,
and D are, respectively, $18, $6, $4, and $24 and Ricardo has an income of $106.

The first step is to convert the marginal utility values into marginal utility per dollar values.
Recall this is MU/P.

Marginal Marginal Marginal Marginal Marginal Marginal Marginal Marginal units

Utility Utility Utility Utility Utility Utility Utility Utility
per dollar per dollar per dollar per dollar per dollar per dollar per dollar per dollar
unit 1 unit 2 unit 3 unit 4 unit 5 unit 6 unit 7 unit 8
Column 1 4.00 3.00 2.50 2.00 1.50 1.00 0.83 0.67 4
Good A
Column 2 4.00 2.50 2.00 1.50 1.17 0.83 0.33 0.17 3
Good B
Column 3 3.75 3.00 2.00 1.75 1.25 1.00 0.88 0.75 3
Good C
Column 4 1.50 1.25 1.00 0.75 0.54 0.29 0.17 0.08 0
Good D
Column 5 5.00 4.00 3.00 2.00 1.00 0.50 0.25 0.13 4
Saving
 is marginal utility per dollar for good A). The columns represent the marginal utility per
dollar for the different goods for each unit consumed and saving (for example, column 1
'Marginal Utility per dollar unit 1' tells us the marginal utility per dollar for the first unit of
every good and savings). This will makes the comparison a little easier.

To determine the optimal amount of goods that Ricardo will purchase, we choose the goods
with the highest marginal utility per dollar as we move from left to right. We continue to do
this until income is exhausted. We see that the first unit of savings ($1) provides $5.00 worth
of utility per dollar, so Ricardo makes this choice. Next he purchases one unit of good A and
good B with a marginal utility per dollar of 4 He will also save the second dollar (an
additional $1) because the marginal utility per dollar is 4. The next decision leads Ricardo to
purchase the first unit of good C with a marginal utility per dollar of 3. Then he moves on to
purchase the second unit of good A, the second unit of good B, and he saves an additional
dollar because the marginal utility per dollar is 3for these goods. After these purchases, he has
an income left of $53. Since he has income left, he continues to buy more goods using the
approach above.

In conclusion, Ricardo will consume 4 units of good A, 3 units of good B, 3 units of good C,
zero units of good D, and saves $4. This will exhaust his income $106 (= $18 x 4 + $6 x 3 +
$4 x 3 + $24 x 0 + $4).

5. You are choosing between two goods, X and Y, and your marginal utility from each is as shown in
the table below. If your income is $9 and the prices of X and Y are $2 and $1, respectively, what
quantities of each will you purchase to maximize utility? What total utility will you realize? Assume
that, other things remaining unchanged, the price of X falls to $1. What quantities of X and Y will you
now purchase? Using the two prices and quantities for X, derive a demand schedule (prices and
quantities demanded table) for X. LO3

Answer: X = 2 units, Y = 5 units; total utility = 48; X = 4, Y = 5; Demand schedule =

Price Demanded Quantity Demanded
2 2
1 4

Feedback: Consider the following table and information as an example:

 Your income is $9 and the prices of X and Y are $2 and $1, respectively.

The first step is to convert the marginal utility values into marginal utility per dollar values.
Recall this is MU/P. See the table below.

Margina Margina Margina Margina Marginal Marginal Units

l Utility l Utility l Utility l Utility Utility Utility
per per per per per per
dollar dollar dollar dollar dollar dollar
unit 1 unit 2 unit 3 unit 4 unit 5 unit 6
Good Y 8.00 7.00 6.00 5.00 4.00 3.00 5
(first price)
Good X 5.00 4.00 3.00 2.00 1.50 1.00 2
(first price)
Good Y 8.00 7.00 6.00 5.00 4.00 3.00 5
(second
price)
Good X 10.00 8.00 6.00 4.00 3.00 2.00 4
(second
price)

The first two rows define the marginal utility per dollar for goods X and Y when the price of
good X is $2 and the price of Good Y is $1. Each column is the marginal utility for the unit
consumed (Marginal utility per dollar for unit 1 is for the first unit consumed, Marginal utility
per dollar for unit 2 is for the second unit consumed, etc...).

To determine the optimal number of goods to purchase we choose the goods with the highest
marginal utility per dollar as we move from left to right. We continue to do this until income
is exhausted.

First, we only consider the first two rows for Goods X and Y for the first price of good X
(price of X is $2). We purchase the first unit of good Y with a marginal utility per dollar of 8.
Next we purchase the second unit of good Y with a marginal utility per dollar of 7. Followed
by the third unit of good Y with a marginal utility per dollar of 6. Continuing on, we purchase
the fourth and fifth unit of Good Y and the first and second unit of good X 5and4marginal
utility per dollar). Thus, we purchase 5 units of good Y and 2 units of good X. The total cost
is $9 (= $5 x 5 + $2 x 2), which exhausts income.
 The total utility is then found by adding up the marginal utility values for the goods consumed
using the values in the original table. The total utility from good Y is 30 (=8 + 7 + 6 + 5 + 4)
and the total utility from good X is 18 (=10 + 8). The sum of these two values is the total
utility, which equals 48 (=30 + 18).

Now we consider the case where the price of good X falls to $1.

Here, we only consider the last two rows for Goods X and Y for the second price of good X.
Here our first purchase is the first unit of good X with a marginal utility per dollar of 10. Next
we purchase the second unit of good X and the first unit of good Y with a marginal utility per
dollar of 8.00. We continue this process until income is exhausted. The optimal consumption
level for good X is 4 and for good Y is 5.

This gives us the ordered pairs for good X: (P = 2, Q = 2) and (P = 1, Q = 4). We can use
these ordered pairs to graph the demand schedule (not required).

2)
Questions
2.What information is contained in an indifference curve? Why are such curves (a) downsloping and
(b) convex to the origin? Why does total utility increase as the consumer moves to indifference curves
farther from the origin? Why can’t indifference curves intersect? LO6

Answer: Every point on an indifference curve shows some combination of two

products that will give equal utility to a consumer; that is, each combination of the two
products has the same level of total utility. Indifference curves are:
(a) Downsloping because both products yield utility to the consumer. Going down the
curve means more of one commodity is being consumed, thus increasing the consumer’s total
utility. To keep total utility constant, some amount of the other commodity must be given up
to precisely offset the gain in total utility. Thus, the quantities of the two commodities are
inversely related. Any curve showing an inverse relationship is downsloping.
(b) Convex to the origin because the consumer’s willingness to give up more of one
commodity to get more of another diminishes as more and more of one commodity is
substituted for the other. When the consumer has much of one commodity but little of the
other, the consumer will resist more and more giving up what little still remains of the first
commodity. This resistance is shown by the consumer demanding a great deal of the
abundant commodity in exchange for a small amount of the scarce commodity. Technically
expressed, the marginal rate of substitution declines as one moves southeast along an
indifference curve.
3. Using Figure 4, explain why the point of tangency of the budget line with an indifference
curve is the consumer’s equilibrium position. Explain why any point where the budget line intersects
an indifference curve is not equilibrium. Explain: “The consumer is in equilibrium where MRS=
PB/PA.” LO6

Answer: The tangency point places the consumer on the highest attainable
indifference curve; it identifies the combination of goods yielding the highest total utility.
All intersection points place the consumer on a lower indifference curve. MRS is the slope of
the indifference curve; PB/PA is the slope of the budge line. Only at the tangency point are
these two slopes equal. If MRS > PB/PA or MRS < PB/PA, adjustments in the combination
of products can be made to increase total utility (get to a higher indifference curve).