CHAPTER 6
1. Answers will vary because the question asks for personal
choices; however, it is likely that students may offer some of the following in
response:
(a) If other prices and your income remain
constant, you are likely to see your friend less frequently. Of course there
may be available substitutes. You may have a car and you might drive more
often. A discount airline or a train may now have relatively cheaper ways to
get there.
(b) Students might consume more of other goods
(e.g., movies, clothing) because with lower tuition they have more money to
spend on other things. They may also work fewer hours, assuming they mostly
work to pay tuition. Instead of spending more, they may also save the money
they did not have to spend on tuition.
(c) This represents an increase in income for the
next five years; again, students may spend it on any number of goods, may use
that added income to allow them to work fewer hours, or may save it (resulting
increased saving).
(d) A higher interest rate could have a positive
or negative impact on saving. First of all the opportunity cost of spending
today is higher. Thus, households would tend to save more (substitution
effect). On the other hand, if you already have a lot of saving, you will earn
a higher return on it, and you will have to save less than you did when
interest rates were lower to achieve the same level of income in your
retirement (income effect). If you have savings, the higher return will give
you more income. If, on the other hand, you are a net borrower, then the
interest rates on your loans may increase, making you worse off. Answers will
also vary.
(e) Having to spend more money on food will likely
leave students with less money to spend on other goods (e.g., movies, CDs,
etc.), and may mean they have to work more hours. Students may also draw down
savings or just save less as a result of increased expenditure on food. (This
assumes that they do not drastically decrease the amount of food consumed as a
result of the higher price!)
(f) Students may work more hours because of the
high wage or may work fewer hours since they are earning so much more per hour
(than minimum wage, for example). If the result is higher income, students will
buy more of any number of goods (including leisure). They may also be able to
save more.
2.
|
# of Cookies
|
Marginal Utility
|
|
1
|
100
|
|
2
|
100
|
|
3
|
75
|
|
4
|
50
|
|
5
|
25
|
|
6
|
10
|
|
7
|
0
|
The
maximum he would buy is 6 because the seventh yields no marginal utility.
3. (a) She can no longer afford to buy the same
combination of things that she bought last year. Her real income is lower.
Something has to give—her budget constraint changed. So, she must cut back on
some things, and her preferences dictate that concerts and clothing takes a hit.
(b) She is worse off—her real income is lower—she
will reduce consumption of normal goods including air trips home; this is the
income effect. In addition, the opportunity cost of a trip home increases from
$350 to $600. Thus, Kamika will be pushed to substitute other goods for air
travel. This is the substitution effect.
4.
|
5.
|
(a,c)
|
 |
(b)
|
10 lunches at the club, and 5
at
 $5 + 5$10 = $100. This is within the
budget constraint. |
6. This statement
is backwards. An increase in the “after-tax” wage will have a positive effect
on the labor supply only if the substitution effect outweighs the income
effect. The substitution effect states that a higher wage makes the opportunity
cost of leisure increase. Thus, people tend to substitute work for leisure. The
substitution effect alone suggests that a higher after-tax wage leads to more labor supply. On the other hand,
if the after-tax wage goes up, people are better off. Assuming leisure is a
normal good, the higher wage suggests that people will consume more leisure and
work less.
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