Nonetheless, society generally assumes that extra income would yield more utility to a lowincome person than to a high-income person. And hundreds of billions of dollars in income are redistributed each year, generally from persons with more income to persons with less income, with the goal of increasing total utility for society. (We will look more closely at income distribution and redistribution in Chapter 31.) Diamond-Water Paradox Is the price of a good related to the utility received from consuming the good? Logically, we would expect the price of a good to be related to the good’s utility. If Bertram is willing to pay $6 for a chili dog, Bertram must be anticipating at least $6 worth of utility from consuming the chili dog. But what about the diamond-water paradox? Diamond-water paradox – the observation that essential goods are often lower priced than nonessential goods. Some goods that are essential to life (like water) have a very low price. Other goods that are nonessential (like diamonds) have a very high price. This seems paradoxical. Shouldn’t a good’s price be related to its utility? Actually, it is. The price of a good is equal to the marginal utility of the last unit of the good consumed. This is the explanation of the diamond-water paradox. Water has a very high total utility. A person would be willing to pay a very high price to have sufficient water for drinking purposes. Example 6: If the only source of drinking water had a price of $20 per gallon, a person would willingly pay the high price rather than perish from thirst. But a person consumes many units of water, for a variety of uses. The first units of water purchased have very valuable uses, such as drinking. As more units of water are consumed less valuable uses are made of water, such as bathing, washing clothes, washing cars, watering flowers, etc. The last units of water consumed have a very low marginal utility, and are consumed only because of the very low price of water. If water had a price of $20 per gallon, a person would not buy water for its less valuable uses. (Good luck, flowers, you are on your own.) A person consumes few diamonds. The last diamond consumed has a very high price, and is consumed only because the buyer expects a very high marginal utility. If diamonds were more abundant and had a lower price, they would be consumed for less valuable purposes. If diamonds were as abundant as gravel, they would be used to pave driveways. So which is more valuable, water or diamonds? Water is more valuable than diamonds in terms of total utility, but diamonds have a higher marginal utility, and thus a higher price. Example 7: Pat buys a diamond engagement ring in March, paying $2500. Pat’s water bill in March is $30 for 1,500 gallons of water, or an average price of 2¢ per gallon. The diamond ring provides Pat with more marginal utility than the fifteen hundredth gallon of water (which dripped out of a leaky faucet). But the water that Pat consumed in March provided Pat with more total utility than the diamond ring. Utility Maximization Consumers will attempt to maximize the utility (satisfaction) that they receive from their limited incomes. To determine the utility-maximizing combination of goods to consume requires consumers to consider how much marginal utility different goods yield, and also the prices of the different goods. To illustrate this, assume that Consumer A is trying to choose the combination of Good X and Good Y that will maximize Consumer A’s utility. Good X and Good Y yield the amounts of total and marginal utility to Consumer A indicated on the table on the next page: FOR REVIEW ONLY - NOT FOR DISTRIBUTION 18 - 3 Utility
Good X Good Y Units Total Marginal Units Total Marginal of X Utility Utility of Y Utility Utility 0 0 X 0 0 X 1 40 40 1 30 30 2 75 35 2 55 25 3 105 30 3 75 20 4 130 25 4 90 15 5 150 20 5 100 10 6 165 15 6 105 5 7 175 10 7 109 4 8 180 5 8 112 3 Example 8A: Assume that Consumer A has $1 of income, and that Goods X and Y each cost $1 per unit. Consumer A would buy one unit of Good X. The first unit of Good X yields 40 marginal utils and the first unit of Good Y yields only 30 marginal utils and they both cost $1. Utility Maximization Rule No. 1 – Always choose the marginal unit of the good that yields the most marginal utility per price. Example 8B: Assume the same facts as Example 8A, but now Consumer A has $2 of income. Consumer A would buy two units of Good X. This follows Utility Maximization Rule No. 1 Example 8C: Assume the same facts as Example 8A, but now Consumer A has $10 of income. Consumer A would buy six units of Good X and four units of Good Y. This combination yields 255 total utils. No other combination of Goods X and Y yields as much total utility for $10. With this combination of Goods X and Y, the ratio of marginal utility per price is equalized for Goods X and Y. The sixth unit of Good X and the fourth unit of Good Y both yield 15 marginal utils for $1. Utility Maximization Rule No. 2 – Always choose the combination of goods that equalizes the ratio of marginal utility per price for all goods. Example 8D: Assume the same facts as Example 8C but now Good Y costs $3. Consumer A would buy seven units of Good X and one unit of Good Y. This combination yields 205 total utils. No other combination of Goods X and Y yields as much total utility for $10. The ratio of marginal utility per price is equalized for Goods X and Y. The seventh unit of Good X yields 10 marginal utils for $1, the first unit of Good Y yields 30 marginal utils for $3. Thus the ratio of marginal utility per price is the same (10 marginal utils per dollar) for the last units of both Good X and Good Y. Example 8E: Assume the same facts as Example 8C but now Good Y costs $2, and Consumer A has $13 of income. Consumer A would buy seven units of Good X and three units of Good Y. This combination yields 250 total utils. No other combination of Goods X and Y yields as much total utility for $13. The ratio of marginal utility per price is equalized for Goods X and Y. The seventh unit of Good X yields 10 marginal utils for $1, the third unit of Good Y yields 20 marginal utils for $2. Thus the ratio of marginal utility per price is the same (10 marginal utils per dollar) for the last units of both Good X and Good Y. Providing Essential Goods Free of Charge The distribution of income in the U.S. economy is unequal. Persons with very low income may be unable to afford essential goods, such as food, shelter, etc. Should essential goods be distributed through markets like other goods? Should low-income persons be forced to do without essential goods because they cannot afford the market price? Should the government provide essential goods to everyone (or at least to those with low income) free of charge? Then no one would have to do without essential goods. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Utility 18 - 4
PRINCIPLES OF ECONOMICS JEFF HOLT S
Principles of Economics, 6th Editio
16. Study Guide for Chapter 7 17. C
11. Appendix: Book Review - “The
20. Appendix: The NCAA Cartel 21. S
Introduction: A Brief History of U.
In the twentieth century, per capit
Appendix: The 35 Largest National E
Multiple Choice: ___ 1. The Jamesto
2. Describe the economic cost of th
Chapter 1 Scarcity and Choices The
Example 5B: At the end of 1982, the
Example 11: When Cindy quits her jo
consequences may result in failure
An upward sloping curve (as in Exam
In making decisions, humans tend to
5. ______________________ _________
___ 13. If the value of one variabl
Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7
Chapter 2 Trade and Economic System
Example 4B: The following quantitie
1. An increase in the quantity of r
3. For whom to produce? This is det
The graph below illustrates the shi
The two primary economic systems ar
___ 12. The capitalist vision sees
___ 25. According to the book “Ca
Chapter 3 Demand, Supply, and Equil
. For inferior goods, income and de
The same information can be placed
Not only does a free market elimina
$7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3
Example 17: The graph below illustr
Questions for Chapter 3 Fill-in-the
___ 12. Assuming a market originall
$8 - 7 - 6 - 5 - Price 4 - 3 - 2 -
Chapter 4 Inflation and Unemploymen
Computing the Rate of Inflation The
Full Employment Though unemployment
3. Cyclical unemployment - due to d
During the Great Depression, the ec
Appendix: Think Like an Economist -
Answer questions 8. and 9. based on
___ 25. The extension of unemployme
Chapter 5 Measuring Total Output: G
5. Leisure. Leisure time is by defi
The U.S. is a high per capita GDP c
Example 17: In “An International
The simple circular flow diagram be
___ 3. Which of the following would
2. Explain what nonproduction trans
Chapter 6 The Aggregate Market The
Example 2C: Assume the same facts a
Example 5B: The price of crude oil
Price Level Real GDP SRAS AD 2 AD 1
Appendix: Why the Aggregate Demand
___ 3. DEF Company can invest in ne
2. List and explain the two factors
Chapter 7 Classical Economic Theory
Notice that the investment demand c
Long-Run Equilibrium If Real GDP is
Example 6B: When the economy is in
Laissez-faire If the economy is sel
___ 5. According to Say’s Law: a.
3. On the graph below, draw an aggr
Chapter 8 Keynesian Economic Theory
Example 2B: The graph below illustr
Example 5: Assume that the table be
Notice on the graph on the previous
According to Keynesian theory, a ch
“The General Theory” also inclu
___ 8. If the consumption function
3. If the MPC is .667, and investme
Chapter 9 Fiscal Policy The basic e
Keynesian Fiscal Policy Theory and
Example 5A: The federal government
The Laffer Curve What will happen t
Appendix: The Importance of Incenti
___ 4. A decrease in government exp
2. Explain what automatic stabilize
Chapter 10 Money, Money Creation, a
Example 4B: The castaways on Gillig
Looking at the balance sheet below,
Demand-side One-shot Inflation Exam
4. Inflation increases uncertainty
life; it came into existence not by
calculated by using the potential d
___ 12. If the required-reserve rat
4. Referring to the balance sheet f
Chapter 11 The Federal Reserve Syst
5. After Bank X sells the $300,000
Low Mortgage Interest Rates Mortgag
Relaxed Standards for Mortgage Loan
The Bursting of the Housing Bubble
On February 17, 2009, the federal g
Fed policies caused short-term inte
___ 10. The Fed’s most important
___ 25. In response to the recessio
Chapter 12 Monetary Policy The basi
2. A change in aggregate demand (AD
Monetarist Transmission Mechanism C
3. Borrowers do not have to seek ou
Appendix: Book Review - “The Age
Questions for Chapter 12 Fill-in-th
___ 16. The primary source of incom
7. According to Alan Greenspan, wha
Chapter 13 Taxes, Deficits, and the
Example 5: In 2015, Taxpayer A had
of $5 and a quantity of 10 units. T
The complexity of the tax law also
the current government spending and
cut of 1964. The top rate was lower
___ 6. Federal excise taxes: a. are
3. How would eliminating the loopho
Chapter 14 Economic Growth The basi
2. Labor. Labor can contribute to e
estricting international trade (e.g
An improvement in technology (e.g.
The table below shows the economic
will increase both Real GDP and per
___ 8. Which of the following is co
___ 26. The opinion that economic g
Chapter 15 Less Developed Countries
Example 8: Countries A, B, C, and D
Obstacles to Economic Development f
At what price will there be neither
Appendix: Perfect Competition in th
Multiple Choice: ___ 1. A perfect c
___ 17. Perfect competition: a. req
Answers for Chapter 21 Fill-in-the-
Chapter 22 Monopoly Of the four mar
3. Exclusive ownership of an essent
maximizing quantity (4 units) creat
$22 - 20 - 18 - 16 - 14 - Deadweigh
2. Negotiating, beginning at a high
Legal barriers are created by gover
___ 8. The slope of the demand curv
Price Quantity 3. List some of the
Chapter 23 Monopolistic Competition
For Percomp (the perfect competitor
Example 7A: The graph below represe
Example 9: The Organization of the
Example 12 illustrates the dilemma
its current price and quantity. The
___ 14. Game theory: a. is a method
Answers for Chapter 23 Fill-in-the-
Chapter 24 Factor Markets The basic
$ $240 - 200 - 160 - 120 - 80 - 40
Since producers will attempt to equ
2. Differences in nonmoney aspects
were his strikeouts, walks, and hom
___ 3. To maximize profits, a produ
___ 19. According to the book, “M
Multiple Choice: 1. a. 8. c. 15. d.
Chapter 25 Labor Unions The primary
The elasticity of demand for union
Example 4A: Assume that the graph b
Notice from the graph in Example 6
Wage Factory A Quantity of Labor S
As a cartel, a labor union faces a
___ 10. For a monopsony: a. there i
3. The graph below represents a lab
Chapter 26 Interest, Present Value,
An increase in expected rates of re
An asset is valuable because we exp
Example 13B: General Ordnance prove
Appendix: Present Value Table One f
___ 4. An increase in expected rate
Problems: 1. List and explain the t
Chapter 27 Market Failure The basic
External Benefit If a market genera
Example 2: To encourage the consump
$100 - 90 - 80 - MSC 70 - $ 60 - 50
A common good is nonexcludable. Non
Study Guide for Chapter 27 Chapter
___ 5. What government policy would
4. Based on the information on the
Chapter 28 Public Choice and Govern
Candidates and the Median Voter Mod
Example 8: According to State and F
Example 10: When Elvis Presley was
4. Pessimistic bias. This is the te
___ 5. An elected official will: a.
2. If a certain policy will yield s
Chapter 29 Government Regulation of
underproduction is the amount that
micromanagement results in business
market. They may agree with their c
Questions for Chapter 29 Fill-in-th
___ 10. The public interest theory
4. List the four types of costs imp
Chapter 30 Agriculture and Health C
weather may cause bumper crops. Bad
Security and Rural Investment Act o
Example 12: From 1960 to 2013, the
1. NHI would provide universal heal
d. Insurance providers are not allo
Study Guide for Chapter 30 Chapter
Answer questions 7. through 10. by
___ 21. If there were no individual
Chapter 31 Income Distribution and
Income is more equally distributed
over a typical career is the accumu
Ideal Income Redistribution The ide
Poverty - a family whose income fal
Appendix: Income Inequality around
How is this story an analogy for th
___ 2. In 2013, the Lowest Income 6
Problems: 1. Explain the two primar
Absolute advantage - when one natio
Fiat money - money by government de
Nonrivalrous good - a good for whic
Absolute advantage, 16-9 Absolute e
“Company town”, 25-6 Comparativ
Eli Lilly and Company, 22-1 Emergen
Houston, Texas, 15-10 Human capital
Market, 3-1, 3-8-9 Market basket, 4
Political bias, 9-4, 12-7 Political
Short run production, 20-2-3 Short-
Upturns, 9-4 USDA, 27-9, 30-1-2, 30
Change language