Applied Economics Problems

Chapter 5, Question one

Background information

In this case, having that Bridget consumes two products only, Wine and cheese; she needs to come up with a combination that maximizes her utility. Utility in Economics is defined as the ability of a good or service to satisfy human wants. Normal goods have diminishing marginal utility. This means that consumption of an extra unit of a product yields more utility that the consumption of the previous unit (This utility derived from the consumption of an extra unit is the one called marginal utility. This continues up to some point when the marginal utility starts to decrease. This curve goes on and at some other point; it levels off to mean that the marginal utility is zero. The meaning of this is that the consumption of an extra unit does yield any additional utility. Beyond this point, marginal utility starts to be negative. This illustrates the variable proportions of the marginal utility of a normal good. The curve below illustrates the theory of diminishing marginal utility

TU- Total utility

MU- Marginal utility

It is easily seen from the above graph that the Total utility (Red Curve) Increases at a decreasing rate, while the marginal utility (Blue curve) diminishes progressively. The marginal utility diminishes until it reaches zero and further becomes negative. As a good example, most food stuffs fall in the category of normal goods

For abnormal goods (e.g. Addictive goods), the reverse scenario is true. They have increasing marginal utility. This means that the consumption of an extra unit yields higher utility than the consumption of the previous unit.

Now having the above background information, let us analyze the utility that Bridget derives from the consumption of cheese and Wine

Consumption theory allows us to assume that the consumer pays for the value he derives from the consumption of the goods he buys. This being the case, we can comfortably 'measure' utility by equating it to the amount that the consumer pays (this is how the utility column in the table above has been obtained)

The marginal Utility of Cheese is 0 and the marginal utility of Wine is 10

Specific Answers

a) No, Bridget is not making the utility maximizing choice. This is because She buys cheese which according to the computations above is having zero marginal utility

b) Bridget should not buy the units of cheese that have zero marginal utility. Instead, he should buy more units of wine which is having higher marginal utility (than that of cheese). This is because the marginal utility of beer is increasing as that of cheese decreases

Chapter 6 Question 1

Loss= $20 million

Proposed price increase= 50 cents to 75 cents

Estimated resultant additional income= $60 million

Implicit assumptions made by the made by the publisher about price elasticity

1) The publisher assumes that the demand for the papers in the market is perfectly elastic. This is because he thinks that a rise in price would bring the demand for the paper down tremendously

2) The publisher assumes that the demands for Newsweek and The wall Street Journal are directly proportional, so what happens to one due to a price increase could also happen to the other

3) He assumes that Newsweek does not form a very significant portion of the market, so it follows the general rules of price elasticity of demand in the market

4) There is no serious consumer loyalty to the Newsweek brand, so a price increase will automatically make the customer   to shift to the cheaper brands

5) The producer of Newsweek assumes that there exists very close substitutes of the paper such that  a rise in price of Newsweek will make the consumer shift to the other competing papers

6) He also assumes that the degree of necessity of the Newsweek paper is low and hence the high elasticity of its demand

Implicit assumptions made by the made by the analyst about price elasticity

1) The analyst assumes that the degree of necessity of the Newsweek paper is substantially high so the elasticity of its price is low

2) The analyst assumes that the demand for the Newsweek paper is inelastic, to the effect that sales revenue can still go up even with the increase in the price

3) He assumes that the paper (Newsweek) takes a very significant portion of the paper market, hence the inelastic demand

4) He also assumes that the consumers that buy the Newsweek paper are loyal to the product, so they still buy it despite the increase in the price, making the demand inelastic

5) That there are no very close substitutes of the paper , so  the customers will still buy it without worrying about the price increase, again making the demand inelastic

Chapter Seven, Question 1

a) The statistical significance of the parameter estimates is explained using the level of significance (α), as compared to the P Value.

Criteria: When P value < α, the parameter is statistically significant

When P value >α, the parameter is statistically insignificant

Let α= 0.05

b)      Estimated number of tennis balls is given by the following Calculation

Q= a +bP + cM + dPR

Q= 425,120 + (-37,260.6)1.65 +(1.49)24,600 + (-1,456.0)110

c)      Price elasticity=  %%u2206Qdd/%%u2206P

There exists a scenario of perfect elasticities

d)     Q= a +bP + cM + dPR

New Q= 425,120 + (-37,260.6) 1.4025+ (1.49)24,600 + (-1,456.0) 110

%u2206 = 240,134.01 - 249356.01

%%u2206 = (240,134.01 - 249356.01)/ 240,134.01

e)      Q= a +bP + cM + dPR

New Q= 425,120 + (-37,260.6)1.65 + (1.49) 29,520 + (-1,456.0) 110

%u2206 = 240,134.01 - 247,464.81

%%u2206 = (240,134.01 - 247,464.81)/ 240,134.01

f)       Q= a +bP + cM + dPR

New Q= 425,120 + (-37,260.6)1.65 + (1.49)24,600 + (-1,456.0) 137.5

%u2206 = 240,134.01 - 200,094.01

%%u2206 = (240,134.01 - 200,094.01)/ 240,134.01