AP_Krugman_Textbook

522 section 9 Behind the Demand Curve: Consumer Choice

Tackle the Test: Free-Response Questions

1. Refer to the table provided. Assume you have $20 to spend.
   Snacks (price =$4) Drinks (price =$2)
   Quantity Total Utility (utils) Quantity Total Utility (utils)
   115112
   225221
   331329
   434436
   536542
   647
   750
   852
   a. Draw a correctly labeled budget line.
   b. Determine the marginal utility and the marginal utility per
   dollar spent on the fourth drink.
   c. What is the optimal consumption rule?
   d. How many drinks and snacks should you purchase to
   maximize your total utility?

Answer (6 points)

Quantity of drinks

0 10

Quantity of
snacks
5

1 point:Graph with “Quantity of snacks” and “Quantity of drinks” as axis labels.

1 point:Straight budget line with intercepts at 5 snacks and 0 drinks and at 0

snacks and 10 drinks.

1 point:MU=7 utils

1 point:MU/P=3.5 utils per dollar

1 point:Total utility is maximized when the marginal utility per dollar is equal

for all goods.

1 point:6 drinks, 2 snacks

2. Assume you have an income of $100. The price of good X is $5,
   and the price of good Y is $20.
   a. Draw a correctly labeled budget line with “Quantity of good
   X” on the horizontal axis and “Quantity of good Y” on the
   vertical axis. Be sure to correctly label the horizontal and
   vertical intercepts.
   b. With your current consumption bundle, you receive 100
   utils from consuming your last unit of good X and 400 utils
   from consuming your last unit of good Y. Are you
   maximizing your total utility? Explain.
   c. What will happen to the total and marginal utility you
   receive from consuming good X if you decide to consume
   another unit of good X? Explain.

Summary

1.Changes in the price of a good affect the quantity

consumed as a result of the substitution effect,

and in some cases the income effect.Most goods ab-

sorb only a small share of a consumer’s spending; for

these goods, only the substitution effect—buying less

of the good that has become relatively more expensive

and more of the good that has become relatively

cheaper—is significant. The income effect becomes

substantial when there is a change in the price of a

good that absorbs a large share of a consumer’s

spending, thereby changing the purchasing power of

the consumer’s income.

2.Many economic questions depend on the size of con-

sumer or producer responses to changes in prices or

other variables. Elasticityis a general measure of respon-

siveness that can be used to answer such questions.

3.Theprice elasticity of demand—the percent change in

the quantity demanded divided by the percent change

in the price (dropping the minus sign)—is a measure of

the responsiveness of the quantity demanded to

changes in the price. In practical calculations, it is usu-

ally best to use the midpoint method,which calculates

percent changes in prices and quantities based on the

average of the initial and final values.

4.Demand can fall anywhere in the range from perfectly

inelastic,meaning the quantity demanded is unaf-

fected by the price, to perfectly elastic,meaning there

is a unique price at which consumers will buy as much

Section 9 Review