Chapter 6
Question 8
This is a good question to emphasize the difference between total and marginal value and
to clarify how changes in market price are related to changes in either total or marginal
value.
a) The rightward shift of the demand curve reflects the fact that consumers now place more
total value on this item (or, in other words, more value for any given quantity). Thus, for
any given quantity of the product, the area under the demand curve has increased.
b) In equilibrium, the marginal value of X has not changed, even though the total value has.
The reason is that, in this case, the supply curve is perfectly elastic, and so the equilibrium
market price is unaffected by the increase in demand. So consumers still consume X until
the marginal value is equal to the market price, but the latter is unchanged and thus so is the
former.
c) The total value that consumers place on a given quantity of Y is unchanged—the
demand curve for Y has not moved.
d) The increase in supply drives down the price. The reduction in price leads consumers
to consume more of Y until the marginal value is just equal to the price. But since the
price has fallen, the value of Y at the margin has also fallen, even though there has been
no change in preferences (the demand curve hasn’t moved at all).
Question 9
a) The demand and supply curves are plotted in the diagram below. To compute the
equilibrium price and quantity algebraically, we must solve the system of equations.
Equate the prices in the demand and supply functions to get
30 – 4Q* = 6 + 2 Q*  24 = 6 Q*  Q* = 4
Substitute this value of Q* back into either the demand or supply curve to solve for p*.
Using the demand curve to do so, we get
p* = 30 – (4  4) = 14
b) The total value that consumers place on Q* units of the good is shown by the area
under the demand curve up to Q = 14 units. This is shown by areas A + B + C.
c) The value that consumers place on an additional unit of the good—the marginal
value—is shown by the equilibrium market price, p* = 14. Given the market price,
consumers consume the good until the last unit delivers utility equal to the market price.
d) The new supply curve is p = 2 + 2QS. The new equilibrium quantity, Q** is found by
30 – 4Q** = 2 + 2Q**  28 = 6Q**  Q** = 4.67
and p** = 30 – (4  4.67) = 11.33
Consumers’ marginal value of the good has now fallen, along with the equilibrium
market price.
e) Consumers have not changed the total value they place on any given amount of the
good, but their marginal value has fallen. As the equilibrium price falls, consumers
consume more of the product, thus diminishing the marginal value of the product.
Answers to Appendix Study Exercises
Question 2
a) The cost of each bundle is shown in the following table. Since Katie has $18 per month,
she can afford only bundles a, c, f, g, and i. She cannot afford bundles b, d, e, and h.
a
b
c
d
e
f
g
h
i
Cost ($)
18
20
18
19
20
17
18
22
18
b) If Katie spends her entire $18 on ice cream cones, she can afford to buy 9 cones. This is
the vertical intercept of the budget line shown below. If she spends her entire $18 on
videos, she can afford to rent 6 videos. This is the horizontal intercept of the budget line.
The (absolute value of the) slope of the budget line is equal to the “rise over the run”,
which in this case is equal to 9/6, which is 1.5. This slope is equal to the relative price of
videos to ice cream cones (= 3/2 = 1.5).
c) Recall that Katie can only afford bundles a, c, f, g, and i. Which one will she choose?
Recall from Question 1 that Katie prefers bundle g to bundle f, and she also prefers g to
both c and i. So Katie definitely won’t choose c, f, or i. This leaves only bundle a. But from
the figure of the indifference curves above, it is also clear that bundle g is on a higher
indifference curve than bundle a, so she won’t choose bundle a. Thus Katie’s utilitymaximizing choice is bundle g.
Question 3
a) For the budget line given by Line 1, point A shows the tangency between the budget line
and the indifference curve — this shows the highest level of utility that Debra can achieve.
b) If the price of Coronas declined, then the maximum available amount of Coronas (with a
given money income) would increase. This amount of Coronas is the horizontal intercept of
the budget line.
c) Point B shows the hypothetical consumption bundle that Debra would choose if the price
of Coronas declined and her money income was reduced so that she could just achieve her
original level of utility. The movement from A to B is the substitution effect of the
reduction in the price of Coronas. It shows that the substitution effect of a decline in the
price of a product is unambiguously to increase the consumption of that product and
decrease the consumption of the other product.
d) Point C is the new consumption bundle that Debra chooses after the actual reduction in
the price of Coronas. If Coronas are a normal good, then an increase in real income must
lead Debra to increase her consumption of Coronas. This implies that point C must lie to
the right of point B (the movement from B to C being the pure income effect of the price
change). The diagram as drawn does indeed satisfy this restriction.