Assignment: Elasticity of Demand

In this Assignment, you will focus on marginal utility, Price Elasticity of Demand, and understanding the difference between Price Elasticity of Demand and Income Elasticity of Demand.

We all subconsciously assign "scores" to what we are considering to purchase, based on our expected level of "satisfaction" (Marginal Utility) with that purchase. When making simultaneous pairs of purchases, again we subconsciously compare the amount of "satisfaction" (Marginal Utility) that we will receive from the pair of purchases. To decide on the "ideal" combination of these two purchases, we expect that the last dollar we spend on each of the items will give us the "same" satisfaction per dollar (Marginal Utility per dollar). Further, we know that the MORE of an item that we get, the next one we get will give us LESS "satisfaction" Marginal Utility) than the last one gave us (the Law of Diminishing Marginal Utility). Using what you have learned about Marginal Utility and Marginal Utility per dollar, answer the following questions.

Questions

1. Jane has been working all day, missing both her breakfast and lunch. Finally able to leave work, after being required to work a couple of hour's overtime, she is starving. Jane has $20 in her pocket, so she stops at a local fast food restaurant and orders a grilled chicken sandwich (somewhat healthy) and fries (not so healthy). As she sits down to eat them, a Kaplan University student approaches her and tells her that she is doing a research project for her microeconomics course, and would like to ask Jane a few quick questions. Jane agrees and the student asks what "score" (Marginal Utility) from 1 to 100 would she give as her satisfaction level with the 1st sandwich and the 1st fries? After eating that order, Jane is still hungry and orders a second chicken sandwich and another fries. Again, the student asks Jane to give her new scores. Since Jane has not eaten all day, she is hungry enough to order a third round of food and again gives "scores" to the inquisitive student.

Below is the Kaplan student's completed experiment tally sheet of Jane's marginal utility "scores" and the calculation of her marginal utility per dollar, given that each sandwich costs $4.00 and each order of fries costs $2.00, along with her budget of $20. The student filled in the shaded cells based on Jane's responses, then computed the values in the remaining cells. Using this information, answer the following questions:

a. Is Jane maximizing her utility? Explain your reasoning and show any calculations.

Marginal utility is the additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important economic concept because economists use it to determine how much of an item a consumer will buy. Positive marginal utility is when the consumption of an additional item increases the total utility, whereas, negative marginal utility is when the consumption of an additional item decreases the total utility.

Jane is maximizing her utility because the first order gave her some satisfaction and as she makes more orders she will begin to get less satisfaction when compared to her first order.Based on the tally sheet above, Jane's marginal utility per dollar from the chicken sandwich is:

100÷ 4=25
72÷4=18
60÷4=15

b. If Jane is not maximizing her utility, remembering the Law of Diminishing Marginal Utility, would she be better off to buy one less chicken sandwich and one more fry? Explain your reasoning and show any calculations.

As stated by Krugman, & Wells (2014), "[T]he basic idea behind the principle of diminishing marginal utility is that the additional satisfaction a consumer gets from one more unit of a good or service declines as the amount of that good or service consumed rises" (p.284).It would be unnecessary for Jane to buy one less chicken sandwich and one more fry, instead she should buy another chicken sandwich and no fries because the table above shows she seems to receive more satisfaction on the consumption of the chicken sandwich unlike the fries.

c. If Jane is not maximizing her utility with the original purchase combination, remembering the Law of Diminishing Marginal Utility, would she be better off buying just one more fry? Explain your reasoning and show any calculations.

Using the Law of Diminishing Marginal Utility, Jane would not be better off buying one more fry, since the marginal utility she obtains from the fries are lower when compared to the chicken sandwich; therefore, she would be better off ordering another chicken sandwich.

d. If Jane is not maximizing her utility with the original purchase, remembering the Law of Diminishing Marginal Utility, would she be better off buying one less fries and one more chicken sandwich? Explain your reasoning and show any calculations.

Based on Jane's score from the tally sheet, Jane received much more satisfaction from the chicken sandwich when compared to the fries. As a result, this would maximize her marginal utility by purchasing another chicken sandwich instead of another fry.

2. Remembering the Learning Practice in Unit 3, in the year 107 WBCE (Way Before the Common Era) the Gondwanaland Chairman of Production reported that the gosum berry growers were able to meet an average demand of 700 barrels of gosum berries per month at an average a price of $70 per barrel.

In the year 108 WBCE the growers were plagued with a gosum berry bug infestation that reduced average output, causing production to fall to only 600 barrels per month, causing the price to riseto $84 per barrel. The following table shows the Chairman's report:

Using the midpoint method, calculate the price elasticity of demand for Gondwanaland gosum berries. Explain what this price elasticity of demand means?

"The midpoint method is a technique for calculating the percent change. In this approach, we calculate changes in a variable compared with the average, or midpoint, of the starting and final values" (p.146).

Therefore: = ((84-70)/((84+70)/2))/((600-700)/((600+700)/2)) = 14/((77/(-100))/650) = 0.1818/(-0.1538) = - 1.1821

b. What is the monthly average total revenue for year 107, and the monthly average total revenue for year 108? How do these numbers compare to each other?

Change in average total monthly revenue ($50,400-$49,000) = $1,400

Using your answer to part a. above, how could you have predicted this change in total monthly revenue?

Because it is such a small change in price, part A's answercan be used to predict a change in the total monthly revenue; therefore, as the price rises, the quantity demand went down, which represents the law of demand and will have little impact on the total revenue, increasing the monthly revenue with a very slight difference from the current revenue.

3. The Gondwanaland Chairman of Production reported that the new Altair chariots (most modern, horse drawn family chariot) had a PRICE elasticity of 3 and an INCOME elasticity of 2. The supply of these Altair chariots is elastic. Evaluate the following statements and explain why you think they are true, or false.

A 20% increase in the price of the Altair chariot will cause the quantity demanded to fall by an astounding 60%.

This statement is true. A slight increase in price will have a greater impact on the demand; therefore, the demand will fall by three times. The increase in price = (20% x 3) = 60%, which is also equal to the same percentage for a decrease in demand.

An increase in Gondwanaland consumers' incomes will cause prices to rise, but the total quantity demanded will also increase.

This statement is also true. As the Gondwanaland consumers' income increases, it will cause the price to increase as well as the demand.

References:

Marginal Utility Definition Retrieved from http://www.investopedia.com/terms/m/marginalutility.asp#ixzz4KFcozk37

Krugman, Paul. (01/2015). Microeconomics, 4th Edition. [VitalSource Bookshelf Online]. Retrieved from https://kaplan.vitalsource.com/#/books/9781464144820/