Chapter 3: Consumer Behavior

Caterina Muratori

January 20, 2021

1 Multiple Choices
Question 1
Refer to the figure below.

The way in which the indifference curves are drawn in this figure:

a represents a unique case in which two different indifference curves offer the
same level of utility.

b compares three market baskets that yield the same level of utility.

c violates the principle of transitivity in the model of consumer behavior.

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 d represents the usual way in which indifference curves appear on an indifference
map.
Correct answer: C

Indifference curve: Curve representing all combinations of market baskets

that provide a consumer with the same level of satisfaction.

According to this diagram, the consumer should be indifferent among market

baskets A, B, and D. Yet B should be preferred to D because B has more of both
goods (more is better than less assumption). Thus, this situation violates the princi-
ple of transitivity in the model of consumer behavior (transitivity means that if a
consumer prefers basket A to basket B and basket B to basket C, then the consumer
also prefers A to C.)

Question 2
Refer to the figure below.

Which of the following is true concerning the consumer’s marginal rate of sub-
stitution?
a It is diminishing.
b It is positive but varies along the indifference curve.
c It is constant.

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 d It is zero.

Correct answer: C

Marginal rate of substitution (MRS): Maximum amount of a good that

a consumer is willing to give up in order to obtain one additional unit of another
good. It is the magnitude of the slope of the indifference curve.

The indifference curve in the figure is a straight line, so its slope is constant (it
does not change along the line). This implies that the MRS is constant.
As you can see from the figure, the consumer obtain the same level of satisfaction
from 1 (2,3,..) glass of orange juice and 1 (2,3,..) glass of apple juice; thus these
two goods are perfect substitute, i.e. the consumer is indifferent between a glass of
apple juice and a glass of orange juice.

Perfect substitutes: Two goods for which the marginal rate of substitution of
one for the other is a constant.

Question 3
Suppose your utility function for food (F) and clothing (C) is u(F, C) = F + 4C. If
you reduce your clothing consumption by 2 units, how much do you have to increase
your food consumption in order to maintain the same utility level?

a 2 units

b 4 units

c 6 units

d 8 units

Correct answer: D

Utility: Numerical score representing the satisfaction that a consumer gets from
a given market basket.

Utility function: Formula that assigns a level of utility to individual market

baskets.

In this exercise, utility from clothing and food is given by u(F, C) = F + 4C.
This means that one unit of clothing will give to the consumer 4 times the utility
given by 1 unit of food. So, if you reduce your clothing consumption by 2 units,

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you need to compensate this loss with 8 units of food, i.e. 1 unit of food gives 1/4
the utility of 1 unit of clothing, so to compensate for the utility given by 2 units of
clothing you need 8 unit of food: 1/4 · x = 2 ⇒ x = 4 · 2 = 8.

Question 4
A consumer has $100 per day to spend on product A, which has a unit price of $ 7,
and product B, which has a unit price of $15. What is the slope of the budget line
if good A is on the horizontal axis and good B is on the vertical axis?
a -7/15
b -7/100
c -15/7
d 7/15
Correct answer: A

A budget line describes the combinations of goods that can be purchased given
the consumer’s income and the prices of the goods:
I = PX X + PY Y
The slope of the budget constraint is the relative price of the good on the x-axis in
terms of the good on the y-axis.

Thus, in this case the slope is equal to − PPBA = − 15

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.

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Question 5
To simplify our consumption models, suppose U.S. consumers only purchase food
and all other goods where food is plotted along the horizontal axis of the indifference
map. If the U.S. Congress passes an economic stimulus package that pays $ 300 to
each person, how does this affect the budget line for each consumer?

a Makes the budget line steeper

b Makes the budget line flatter

c Parallel outward (rightward) shift

d Parallel inward (leftward) shift

e None of the above

Correct answer: C

A change in income (with prices unchanged) causes the budget line to shift
parallel to the original line. An increase in the level of income makes the budget
line shift to the right since the consumer has more consumption opportunities.

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Question 6
A consumer maximizes satisfaction at the point where his valuation of good X,
measured as the amount of good Y he would willingly give up to obtain an additional
unit of X, equals:

a The magnitude of the slope of the indifference curve through that point.

b One over the magnitude of the slope of the indifference curve through that
point.

c PX /PY

d PY /PX

Correct answer: C

Satisfaction is maximized when the marginal benefit - the benefit associated with
the consumption of one additional unit of one good - is equal to the marginal cost
- the cost of the additional unit of that good. The marginal benefit is measured by
the MRS and the marginal cost is measured by the price ratio.
The marginal rate of substitution is, by definition, the maximum amount of a good
that a consumer is willing to give up in order to obtain one additional unit of another
good. Thus, a consumer maximizes satisfaction at the point where his valuation of
good X, measured as the amount of good Y he would willingly give up to obtain an
additional unit of X (marginal benefit of X), equals PX /PY (marginal cost of X).

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Question 7
Pencils sell for 10 cents and pens sell for 50 cents. Suppose Jack, whose preferences
satisfy all of the basic assumptions, buys 5 pens and one pencil each semester. With
this consumption bundle, his MRS of pencils for pens is 3. Which of the following
is true?
a Jack could increase his utility by buying more pens and fewer pencils.
b Jack could increase his utility by buying more pencils and fewer pens.
c Jack could increase his utility by buying more pencils and more pens.
d Jack could increase his utility by buying fewer pencils and fewer pens.
e Jack is at a corner solution and is maximizing his utility.
Correct answer: B

Jack MRS of pencils for pens is 3, means that Jack is willing to give up 3 pens
for 1 additional unit of pencils (M RS = 3/1), i.e. the consumer values pencils more
than pens. The price ratio is equal 10/50 = 1/5. Thus, M RSX,Y > PX /PY .
As you know, the consumer will continue to purchase more of a good until the
marginal benefit is equal to the marginal cost. In this case, he/she will consume
more pencils and fewer pens, until the decrease in the MRS will be such that it will
equal the price ratio.

As a general rule,
• If M RS < P x/P y, the consumer will consume less x and more y.
• if M RS > P x/P y, the consumer will consume more x and less y.
• If M RS = P x/P y, the consumer will not change his/her consumption.

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Question 8
Andy derives utility from two goods, potato chips (Qp ) and Cola (Qc ). Andy receives
zero utility unless he consumes some of at least one good. The marginal utility that
he receives from the two goods is given as follows:

Marginal utility (MU): Additional satisfaction obtained from consuming one

additional unit of a good.

Question 8.1
Refer to scenario 8. What is the total utility that Andy will receive if he consumes
5 units of potato chips (Qp ) and no Cola drink (Qc )?

a 4 utils

b 10 utils

c 30 utils

d 40 utils

e none of the above

Correct answer: D

You need to sum the marginal utility of each additional unit from 1 to 5:

12 + 10 + 8 + 6 + 4 = 40

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Question 8.2
Refer to scenario 8. If the price of potato chips is $0.50 and the price of Cola is
$4.00, and Andy has an unlimited income, how many units of potato chips will he
consume?

a 5

b 6

c 7

d 8

e none of the above

Correct answer: B

He will keep consuming potato chips until an additional unit gives a positive
utility. So he will consume 6 units of potatoes.

2 Exercises
Exercise 1
George has a fixed income and can afford at most 7 units of X if he spends his entire
income on X. Alternatively, if he spends all his income on Y, he can afford at most 6
units of Y. Martha has the same income and faces the same prices, yet she chooses
to buy 2 pieces of X. In equilibrium, what is George’s subjective value of X in terms
of Y? What is Martha’s?

Answer:

In equilibrium, each consumer chooses a consumption bundle so that MRS

(marginal benefit) is equal to the price ratio (marginal cost):

M RSx,y = PX /PY

Defining I = Income,
PX = I/7
PY = I/6

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So,
I/7
M RS = = 6/7
I/6
In equilibrium one unit of X will be worth 6/7 units of Y for both George and
Martha.

Exercise 2
Sally consumes two goods, X and Y. Her utility function is given by the expression
U = 3XY 2 . The current market price for X is $10, while the market price for Y is
$5. Sally’s current income is $500.

a Sketch a set of two indifference curves for Sally in her consumption of X and
Y.

b Write the expression for Sally’s budget constraint. Graph the budget con-
straint and determine its slope.

c Determine the X,Y combination which maximizes Sally’s utility, given her
budget constraint. Show her optimum point on a graph (Partial units for the
quantities are possible). (Note: M UY = 6XY and M UX = 3Y 2 ).

d Calculate the impact on Sally’s optimum market basket of an increase in the

price of X to $15. What would happen to her utility as a result of the price
increase?

Answers:

a
Since indifference curves represent all combinations of market baskets that pro-
vide a consumer with the same level of satisfaction, to draw indifference curves, pick
2 levels of utility and find the values of x and y that hold the total utility constant:
Let U = 60: q
60 = 3XY ⇒ Y = 20
2
x
Indifference curve for U = 60.
To draw this curve substitute for some values of X and Y to find points where the
curve passes:
√
• if X = 1 ⇒ Y = 20 = 4.47
√
• if X = 2 ⇒ Y = 10 = 3.16
√
• if X = 5 ⇒ Y = 4 = 2

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To draw a second indifference curve, choose another level of utility and redo the
same steps:
Let U = 72: q
72 = 3XY 2 ⇒ Y = 24 x
Indifference curve for U = 72.
√
• if X = 1 ⇒ Y = 20 = 4.89
√
• if X = 2 ⇒ Y = 10 = 3.46
√
• if X = 5 ⇒ Y = 4 = 2.19

b
Budget constraint:
I = PX X + PY Y
500 = 10X + 5Y
Y = 100 − 2X
To draw this line find the intercepts on the X and Y axis:

• if X = 0, Y = 100

• if Y = 0, X = 50

The slope is equal to minus the price ratio: −PX /PY = −10/5 = −2.

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c
The maximizing market basket must satisfy two conditions:

1. It must give the consumer the most preferred combination of goods and ser-
vices. Thus, it must stay on the highest as possible individual’s indifference
curve.

2. It must be located on the budget line.

So, to maximize utility, Sally must find the point where marginal benefit = marginal
cost:
M RS = PX /PY
which is the tangency point of the indifference curve and the budget constraint.
Recall: M UY = 6XY and M UX = 3Y 2 (if you want to calculate yourself the
marginal utilities, you just have to compute the partial derivatives with respect to
X and Y of the utility function). We know that M RS = M UX
M UY
,

M UX 3Y 2 Y
M RS = = =
M UY 6XY 2X
PX 10
= =2
PY 5
Set
M RS = PX /PY
Y
= 2 ⇒ Y = 4X
2X

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Sally should consume four times as much Y as X. To determine exact quantities,
substitute Y = 4X into her budget constraint:

I = PX X + PY Y

500 = 10X + 5Y
500 = 10X + 5(4X)
500 = 30X ⇒ X = 16.67
Y = 4(16.67) ⇒ Y = 66.67

To draw the indifference curve that passes through the equilibrium, you need to
find the level of utility associated with that curve. Hence, you have to substitute
the optimal value of X and Y into the utility function:

U = 3XY 2 ⇒ U = 3(16.67)(66.67)2 = 222, 289

Then, substitute this level of utility into the utility function to get the indifference
curve that passes through E:
Let U = 222, 289: q
222, 289 = 3XY 2 ⇒ Y = 222,289
3x
Indifference curve for U = 222, 289.
As before, to draw this curve, substitute for some values of X or Y to find points
that belong to the curve.

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d
If PX0 = 15, the price ratio changes to 3:

PX 15
= =3
PY 5
and the MRS remains unchanged:
Y
M RS =
2X
To find the new optimum basket equate the MRS to the new price ratio:
Y
= 3 ⇒ Y = 6X
2X
and substitute Y = 6X into the budget constraint

500 = 15X + 5Y

500 = 15X + 5(6X)

500 = 45X ⇒ X = 11.11
Y = 6(11.11) ⇒ Y = 66.67
The utility before the price change was (substitute the optimal values of X and Y
into the utility function):

U = 3XY 2 ⇒ U = 3(16.67)(66.67)2 = 222, 289

and after the price change

U = 3XY 2 ⇒ U = 3(11.11)(66.67)2 = 148, 148

Utility fell due to the price change. Sally is on a lower indifference curve.
(Note: Answers may be slightly different due to rounding.)

Exercise 3
Janice Doe consumes two goods, X and Y. Janice has a utility function given by the
0.5 0.5
expression: U = 4X 0.5 Y 0.5 . So, M UX = 2Y
X 0.5
and M UY = 2X
Y 0.5
. The current prices
of X and Y are 25 and 50, respectively. Janice currently has an income of 750 per
time period.

a Write an expression for Janice’s budget constraint.

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 b Calculate the optimal quantities of X and Y that Janice should choose, given
her budget constraint. Graph your answer.

c Suppose that the government rations purchases of good X such that Janice
is limited to 10 units of X per time period. Assuming that Janice chooses
to spend her entire income, how much Y will Janice consume? Construct a
diagram that shows the impact of the limited availability of X.

d Calculate the impact of the ration restriction on Janice’s utility.

Answers:

a
If PX = 25, PY = 50 and I = 750, the budget constraint is:

I = PX X + PY Y ⇒ 750 = 25X + 50Y

b
PX
At the optimum the marginal rate of substitution equals the price ratio M RS = PY
:

2Y 0.5
M UX X 0.5 Y
M RS = = 2X 0.5
=
M UY Y 0.5
X

PX 25 1
= =
PY 50 2
PX Y 1 X
M RS = ⇒ = ⇒Y =
PY X 2 2
Substitute the value of Y into the budget constraint:

750 = 25X + 50Y

X
750 = 25X + 50 ·
2
750 = 25X + 25X
⇒ X = 15
1
Y = X
2
⇒ Y = 7.5

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c
Substitute in the budget constraint the new value of X, X = 10, to find the value
of Y (since Janice spends her entire income):

750 = 25 · 10 + 50Y ⇒ Y = 10

As indicated in the graph below, at Janice’s optimal bundle with the restriction,
M UX
PX
> MPUYY . This implies Janice should consume more X to increase utility. How-
ever, the ration restriction prevents her from doing so. Given the restriction, this is
the best Janice can do.

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d
Janice’s utility without the restriction is:

U (x = 15, y = 7.5) = 4(15)0.5 (7.5)0.5 = 42.43

Janice’s utility with the restriction is:

U (x = 10, y = 10) = 4(10)0.5 (10)0.5 = 40

The ration restriction results in a utility loss of 2.43 utils for Janice.

Exercise 4
The local mall has a make-your-own sundae shop. They charge customers 35 cents
for each fresh fruit topping and 25 cents for each processed topping. Barbara is going
to make herself a sundae. The total utility that she receives from each quantity of
topping is given by the following table:

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 a What is the marginal utility of the 6th fresh fruit topping?

b Of the two toppings, which would Barbara purchase first? Explain.

c If Barbara has $1.55 to spend on her sundae, how many fresh fruit toppings
and processed toppings will she purchase to maximize utility?

d If money is no object, how many fresh fruit toppings and processed toppings
will Barbara purchase to maximize utility?

e Which of the basic assumptions of preferences are violated by preferences

shown in the table above?

Answers:

a
The marginal utility of the 6th fresh fruit topping is -2 utils:

M Uf ruit (6th unit) = 28 − 30 = −2

b
Barbara will purchase the topping that provides the largest marginal utility per
dollar spent. The marginal utility divided by price for the first unit of fresh fruit

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topping is 10/0.35. The marginal utility divided by price for the first unit of pro-
cessed topping is 10/0.25. Thus the first topping purchased will be processed:
10 10
>
0.25 0.35
c
Barbara will continue to purchase toppings, one at a time, until she spends $1.55,
by always selecting the topping that provides the largest marginal utility per dollar
spent. Barbara will purchase 2 processed toppings first, followed by 3 fresh fruit
toppings.

d
If money is no object, Barbara will purchase an additional unit of each topping as
long as the topping provides a positive marginal utility. In this case, 2 processed
toppings and 5 fresh fruit toppings:

M Uf ruit (6th unit) = 28 − 30 = −2

M Upro (3rd unit) = 10 − 20 = −10

e
The preferences used in this problem violate the assumption that consumers always
prefer more of a good to less.

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