NATIONAL UNIVERSITY OF

ENGINEERING
FACULTY OF INDUSTRIAL ENGINEERING AND
SYSTEMS

SOLUTIONARY CHAP. 9 POSSIBILITIES,

PREFERENCES AND CONSUMPTION
Members:

• Antezana Yana, Jhan Ronaldo

• Leon Reque, Luigie Martin – 20167516E
• Diestra Lopes, San Antonio - 20190117F
• Torres Mego, Milton - 20191088J
• Ventocilla Alejandro, Kenneth - 20191126I
CHAPTER 9
1. Sara has an income of 12 dollars a week. A bag of popcorn costs $3 and a cola costs $3.
a. What is Sara's real income in terms of cola?
R=Revenue/Refreshment Cost = 12/3 = 4
The actual income of cola is 4.
b. What is your real income in terms of bags of popcorn?
R=Revenue/Cost of popcorn = 12/3 = 4
The actual income of popcorn is 4.
c. What is the relative price of soda in terms of popcorn?
R=Price of 1st good/Price of 2nd good = 3/3 = 1
d. What is the opportunity cost of a can of soda?
A=I must sacrifice a bag of popcorn to consume a can of soda.
e. Calculate the equation for Sara's budget line
12=Qm+3Qc
Qm=12-3Qc/3
Qm=4-1Qc
[Link] a graph of Sara's budget line where the soft drink is located on the x-axis.
g. What is the slope of Sara's budget line? What determines its value?
Slope -1
Each increase in the amount of soda by 1 decreases the amount of popcorn by one.
2. Sara's income decreases from 12 to 9 dollars a week. The price of popcorn remains at $3
per bag and that of soda remains at $3.
a. What is the effect of Sara's decreased income on her real income in terms of soft drinks?
Income/Refreshment Cost = 9/3 = 3
The actual income of cola is 3.
b. What is the effect of Sara's decreased income on her real income in terms of popcorn?
Revenue/Cost of popcorn = 9/3 = 3
The actual popcorn income is 3.
c. What is the effect of Sara's decreased income on the relative price of Soft Drink in terms of
popcorn?

Price of 1st good/Price of 2nd good = 3/3 = 1

[Link] is the slope of Sara's new budget line if it is obtained by budgeting the milkshakes on
the X axis?
SLOPE=-1
What determines its value is the variation in the amount of popcorn between the
variation in the amount of soft drink that can be consumed

Use the following information to solve problems 9 and 10.

Sara's income is 12 dollars per week. The price of popcorn increases from $3 to $6 per bag, and
the price of smoothies remains at $3 per unit.

9. What effect does the increase in the price of popcorn have on Sara's real income from
smoothies? And about your real income regarding popcorn?

At the beginning 12 = 3 m +3 s after the increase in the price of popcorn 12 = 6m+3s

Where m: quantity of popcorn (bag)

s: quantity of smoothie your real income decreases, since you buy less smoothie than before.
The actual income regarding popcorn remains unchanged.
10. What effect does the increase in the price of popcorn have on the relative price of a
smoothie in terms of popcorn? What is the slope of Sara's new budget constraint line if we plot
it with the smoothies on the x-axis?

Relative price (PR) of a smoothie in terms of rosettes at the beginning.

Q3
P
R 0 = ^^ = 3 = 1

Relative price (PR) of a smoothie in terms of rosettes at the beginning.

Q 6
8=-= 2
Q 3
There is an increase in the relative price. new slope of the budget constraint is
And the -1/2.

Preference and indifference curves

11. Draw figures showing your own indifference curves for the following pairs of goods:
• Gloves for the right hand and gloves for the left hand.
• Coca-Cola and Pepsi.
• Tylenol and acetaminophen (generic component of Tylenol).
• Desktop computers and laptops.
• Strawberries and ice cream.

Does each of these pairs represent perfect substitutes, perfect complements, substitutes,
complements, or no relationship at all?
12. Analyze the shape of the indifference curve for each of the following pairs of goods:
• Orange juice and smoothie.
• Baseball balls and baseball bats
• Running shoe for the left foot and running shoe for the right foot.
• Glasses and contact lenses.
Explain the relationship between the shape of the indifference curve and the marginal rate of
substitution as the quantities of both goods change.

• Orange juice and smoothie.

Only one of the goods is acquired, therefore, they are perfect substitutes and the curve is a line
with a negative slope, therefore, their marginal rate of substitution is a/b.

• Baseball balls and baseball bats

Both goods have to be acquired, therefore, they are complementary and their marginal rate of
substitution is a/b given that the curve is a straight line with a positive slope.

• Running shoe for the left foot and running shoe for the right foot.
They are perfect complements since the same amount of each good must be consumed, their
indifference curve is shaped like an “L”.

• Glasses and contact lenses.

They are perfect substitutes, since only one of the goods can be consumed where its
indifference curve is a line with a negative slope and with a marginal rate of substitution a/b.

Use the following news clip to solve problems 13 and 14.

Medical problem

The medication Sadafed, used against allergic conditions, contains pseudoephedrine as an

active ingredient, an element widely used to manufacture homemade methamphetamine.
Consequently, allergy sufferers who wish to purchase Sudafed have to show photo
identification and sign a register to do so. The most common alternative, phenylephrine, is not
as effective as pseudoephedrine.

Source: Time, December 4, 2006.

13. Draw an indifference curve for Sadafed and phenylephrine so that it is consistent with
what is mentioned in the article. Identify in your graph the preferred, non-preferred
combinations, and those that cause indifference among patients with allergies.
All combinations that belong to the indifference curve cause indifference to patients with
allergies.
14. Explain how the marginal rate of substitution changes when a patient happily increases his
or her consumption of Sudafed.
Its marginal rate of substitution is the slope of the tangent line to the indifference curve, in this
case when a patient increases his or her consumption of Sudafed, decreasing his or her
marginal rate of substitution.

Use the following news clip to solve problems 15 and 16.

Gasoline prices hamper vacations
Due to the increase in the price of gasoline, 12% of people surveyed stated that they had
canceled their vacation trips to take advantage of the official Memorial Day holiday; another
11% chose to take trips to places closer to their place of residence. This choice undoubtedly
saved consumers some money, but it also negatively affected gas stations, which sold less
gasoline and gasoline, as well as highway hotels, which had more vacant rooms and served
fewer meals.
Source: Market Watch, May 22, 2008.
15. Describe the degree of substitution between Memorial Day vacation travel and other
goods and services related to it. Draw a map of consumer preferences that illustrates your
description.

DEGREE OF SUBSTITUTION OF MEMORIAL DAY AND HOTELS: According to the degree of

substitution and according to the example, we find that the goods are perfect substitutes since
they cannot be consumed at the same time.

PREFERENCES MAP.

Hotels

Predicting consumer choices

16. to. Map consumer preferences between Memorial Day travel and other goods and
services. Draw a consumer's budget constraint line before the increase in the price of gasoline,
and determine the consumer's best affordable point.

The best affordable point is A

b. Show on your graph how the best affordability point changes when the price of gasoline
increases.
The best affordable point is B.

Use the following information to solve problems 17 and 18.

Pam has made your best affordable choice of cookies and granola bars. She spends her entire
weekly income on 30 cookies (one dollar each) and five granola bars (two dollars each). Next
week, the price of cookies is expected to drop to 50 cents and the price of granola bars to rise
to $5.

17. to. Will Pam be able and willing to buy 30 cookies and five granola bars next week?

Y = P G Q G + P BG Q BG
Y=1*30+2*5
Y = $40
Pam's weekly income is $40.

If the price of cookies drops to 50 cents and the price of bars increases to five dollars, then:
„ AND P B g
Q
g PG p-QBG
40 5
Q.G.
0.5 0.5QBG
Q 0=80-10 Q BG
If we replace 30 cookies and five granola bars it meets the new budget equation, so YES YOU
WILL BE ABLE TO MAKE THAT PURCHASE.

b. Which situation would Pam prefer: cookies for one dollar and granola bars for two dollars, or
cookies for 50 cents and granola bars for five dollars?
As seen in the graph, she can
choose either of the two situations,
because it does not affect the
quantities she wants to buy.

Quantity of Granola Bars (Q BG )

18. to. If Pam changes the way she
spends her weekly income, will she buy more cookies or fewer? More granola bars or less?
Pam can change how she spends her income based on the following budget equation QG = 40 -
2 Q BG . If you increase the number of cookies you consume then the number of granola bars you
consume will decrease and vice versa.
b. When prices change next week, will there be an income effect, a substitution effect, or both?
Neither effect occurs, because on the graph the point is the same before prices increase and
after prices increase. A substitution effect, or an income effect, would occur when Sam's
income decreases or increases, as the case may be.
Use the following information to solve problems 19 and 20.
Boom times for “well used” clothing
Almost all retailers blame the economic situation for their low sales; However, a department
store chain that sells used brand-name clothing, toys and children's furniture has spoken out to
claim that poor economic conditions may in fact mean a rebound for its business. Last year the
company had sales of 20 million dollars, which represented a five percent increase over the
previous year. This year its sales have already increased another five percent.
Source: CNN, April 17, 2008
19. to. According to the news clip; Is used clothing a normal good or an inferior good?
Used clothing is an inferior good, because as people's income decreases, the demand for this
good increases. This may be because the people who use it have fewer resources and do not
cover their basic needs.
b. If the price of used clothing decreases and income remains unchanged, explain how the
quantity of clothing purchased changes.
Because it is an inferior good, a reduction in price increases the quantity of clothing purchased.
c. If the price of used clothing decreases and income remains unchanged, describe the
substitution effect and income effect that occur.
In inferior goods, the substitution effect caused by a reduction in price increases the quantity
demanded, but the income effect, being negative, acts in the opposite direction and offsets the
substitution effect.
20. to. Use a graph to illustrate a family's indifference curves for used clothing and other goods
and services.
The graph shows that as there is an increase in income (red line), the amount of used clothing
purchased decreases. This would show that used clothing is an inferior good.

Quantity of Clothing Used

b. On the graph you used to solve (QRU)
part (a), draw two budget constraint lines to show the effect
that the decrease in income has on the quantity of used clothing purchased.
A decrease in point B Income increases the quantity of used clothing purchased from point A
to

ECONOMICS IN THE NEWS (Syllabus 9.N)

Use the following information to solve problems 21 and 22

Gasoline prices add users to mass transportation

As the price of gasoline reaches almost four dollars per gallon, more and more people are
giving up their cars in favor of taking the train or bus. It is quite clear that a very significant part
of the increase in the number of users of these transports is directly caused by people looking
for alternatives to avoid paying $3.50 for a gallon of gasoline. Some cities with well-established
public transportation systems, such as New York and Boston, have seen ridership increases by
five percent, but the largest increases—10 to 15 percent last year—are occurring. occurring in
many metropolitan areas of the southwest, where the culture of car use is higher and rail and
bus lines are more limited.

Source: The New York Times , May 10, 2008

21. to. Draw a graph that includes a preference map and a budget constraint line to illustrate
the best affordable combination of gasoline and public transportation.

b. Show on your graph the effect of an increase in the price of gasoline on the quantities of
gasoline and public transportation services purchased.

An increase in the price of gasoline moves from point C to point D.

Gasoline

22. If the increase in the price of gasoline has been similar in all regions, compare the marginal
rates of substitution that occur in the northeast and the southwest. Explain how you inferred
the different marginal rates of substitution from the information given in the article.

As the price of gasoline reaches almost $4 per gallon, people stop using their cars and use treos
or buses more, consequently the marginal rate of substitution decreases. In the case of the
northeast, the SMR is a little lower than the SMR of the southeast, because
In the southeast, the number of users who used public transportation increased much more,
compared to those in the northeast.
CONSUMPTION POSSIBILITIES

Use the following information to solve problems 23 to 26.

Mare has a budget of $20 a month to spend on root beer and DVDs. The price of root beer is
five dollars a bottle and the price of a DVD is $10.

23. What is the relative price of a root beer to a DVD, and what is the opportunity cost of a
bottle of root beer?

The relative price of a root beer to a DVD is:

NATIONAL UNIVERSITY OF ENGINEERING...........................................................1
FACULTY OF INDUSTRIAL ENGINEERING AND SYSTEMS.............................1
SOLUTIONARY CHAP. 9 POSSIBILITIES, PREFERENCES AND
CONSUMPTION...........................................................................................................1
CHAPTER 9...............................................................................................................2
Preference and indifference curves......................................................................3
Medical problem..................................................................................................6
Gasoline prices hamper vacations........................................................................7
Predicting consumer choices...............................................................................8
Boom times for “well used” clothing................................................................10
Gasoline prices add users to mass transportation..............................................12
CONSUMPTION POSSIBILITIES..................................................................14
BUDGET CONSTRAINTION MARC................................................................15
AMY'S BUDGET CONSTRAINT.......................................................................16
AMY'S BUDGET CONSTRAINT.......................................................................17
Gasoline prices put pressure on budgets............................................................17
Budget constraint! of a..........................................................................................18
Preferences and indifference curves..................................................................18
35. You may be earning more (or less) than you think.................................20
Predicting consumer choices.............................................................................21
The economy in the news..................................................................................24

That is, to buy 1 more root beer, she must give up 0.5 DVD or that is the same as saying that to
buy 2 more beers, Mare must give up 1 DVD.

24. Calculate Mare's actual income from root beer. Calculate your actual income from DVDs.
• Real income regarding root beer: 20

AND
pc

That is, Mare's real income is 4 corn beers.

• Actual income regarding DVD:
20 10
That is, Mare's real income is 2 DVDs.

25. Compute Marc's budget constraint equation.

(P c )(Q c ) + (P d )(Q d ) = 20 →5Q c + 10Q d = 20
26. Graph Marc's budget constraint, with the number of DVDs on the x-axis. What is the slope
of Marc's budget constraint line? What determines its value?

BUDGET CONSTRAINTION
MARC

The slope: → Q c = 4 - 2Q d → slope: -2

Use the following information to solve problems 27 to 30.

Amy has $20 a week to spend on coffee and cake. The price of coffee is $4 per cup, and the
price of cake is $2 per slice.

27. Calculate Amy's actual income from pie. Calculate the relative price of cake in terms of
coffee.

a. Amy's actual income in terms of pie is:

AND _ 20
YRp = — > YRp =2 = 10 u

> Amy's actual income in terms of cake is 10 slices.

b. Amy's actual income in terms of coffee is:
YRc = — -> YRc = 20 = 5 u
Pe 4
> Amy's actual income in terms of coffee is 5 cups.
28. Find the equation for Amy's budget constraint (with the coffee cups on the left side).
AMY'S BUDGET CONSTRAINT
29. If Amy's income increases to $24 per week and the prices of coffee and pastries remain
unchanged, describe how her budget constraint line changes.

The budget constraint line shifts 2u to the right

30. If the price of cake doubles while the price of coffee remains at $4 per cup and Amy's
income remains at $20, describe the change in her budget constraint line.

AMY'S BUDGET CONSTRAINT

Use the following news clip to solve problems 31 and 32.

Gasoline prices put pressure on budgets.
As gas prices continue to rise, many people say they have begun to adjust their spending and
make some sacrifices to stay within their budgets. They now drive as little as possible, control
more purchases, eat out and have eliminated other unnecessary expenses.
31.
a. Draw a budget constraint line for an individual who spends his income only on two
goods: gasoline and meals in restaurants. Identify affordable and unaffordable gas and
food combinations.
Budget constraint! of a

b. Draw a second budget line to show how the affordable and unaffordable combinations of
gasoline and restaurant dining change with an increase in the price of gasoline. Describe
how this individual's consumption possibilities change.

Budget constraint! of a

32. How is the relative price of a restaurant meal modified by an increase in the price of
gasoline? How is real income from restaurant meals modified by an increase in the price of
gasoline?

Pr=R, yes P G then increases the

Relative price of a mealdi sm i nu ye,
P.G.
That is to say, for the individual to consume one more unit of food, he or she has to give up
more gasoline units.
Preferences and indifference curves

Use the following information to solve problems 33 and 34.

Rashid only buys books and CDs; The figure presents your preference map.
33.

a. If Rashid chooses to buy three books and two CDs, what is his marginal rate of
substitution?

If a tangent line is drawn to the indifference curve at the point (2, 3), the number of
books consumed is 5 when consuming 0 compact discs, and 5 compact discs when
consuming 0 books, so the MRS = 5 /5 = 1.

Rashid is willing to sacrifice a book for a compact disc and vice versa.

b. If Rashid chooses to purchase two books and six CDs, what is his marginal rate of
substitution?

A tangent line is drawn to the indifference curve at the point (6, 2) and the marginal
rate of substitution changes, having the possibility of consuming 5 books or 10 compact
discs, so the MRS = 5/10 = 1/ 2.

Rashid is willing to sacrifice 2 CDs for a book.

34. Do Rashid indifference curves exhibit a decreasing rate of substitution? Explain why.
Yes, since along the indifference curve it can be observed that it decreases as the
consumption of a good increases, this is a manifestation of the convex nature of the
indifference curves.

35. You may be earning more (or less) than you think

It's very difficult to put a price on happiness, isn't it? However, if you have ever had to
choose between doing a job you like or taking one that pays more but you don't like as
much, you probably would have been interested in having an economist tell you what the
value of job satisfaction is. Trust in superiors is by far the most important factor to
consider. Let's say you have a new boss and because of it your trust in your superiors
increases a little (maybe one point on a scale of 10). That would be equivalent to having a
36 percent salary increase. In other words, a higher level of confidence will increase your
level of overall life satisfaction by about the same amount as a 36 percent salary increase
would.

Source: CNN, March 29, 2006.

a. Measure trust from superiors on a 10-point scale, measure pay on the same 10-point
scale, and think of these factors as two goods. Draw an indifference curve (with
confidence on the x-axis) that is consistent with the information in the article.

b. What is the marginal rate of substitution between trust in superiors and pay received,
according to this article?

According to the marginal rate of substitution, those who work in that company will
have to give up a part of the trust of their superiors, in such a way that they will be able
to obtain an additional salary to what is already destined for them.

c. What implication does the information in the article have regarding the principle of the
diminishing marginal rate of substitution? Is this implication likely to be correct?

The information has no implication with the marginal rate of decreasing situation,
because although a small amount may result, in the long run increasing the assets will
not end in a good result, harming both parties.

Predicting consumer choices

Use the following information to solve problems 36 and 37.

Jim has made his best affordable choice of muffins and coffee. He spends his entire income on
10 muffins at one dollar apiece, and 20 cups of coffee at two dollars a cup. Now the price of
muffins increases to $1.50 and the price of coffee decreases to $1.75 per cup.

36.

a. Will Jim be able and willing to buy 10 muffins and 20 cups of coffee now?

Y=PMQM+PCQC

Y = 1(10) + 2(20)

Y = $50

Jim's income is $50.

The price of muffins increases to $1.50 and the price of a cup of coffee decreases to
$1.75, then:

Y=PMQM+PCQC

50 = 1.50(Q M ) + 1.75(Q C )

200 = 6(Q M ) + 7(Q C )

By replacing the data with 10 muffins and 20 cups of coffee you can see that the
equation meets, so Jim will be able and willing to make the purchase.

b. Which situation would Jim prefer: $1 muffins and $2 coffee per cup, or $1.50 muffins
and $1.75 coffee per cup?
37.

a. If Jim changes the quantities he buys, will he buy more muffins or less? Will you buy
more coffee or less?

According to the equation:

50 = Q M + 2Q C

Buying a larger quantity of muffins would buy fewer cups of coffee, and buying a larger
quantity of coffee cups would buy fewer muffins.

b. When prices change, will there be an income effect, a substitution effect, or both?

It has no effect, since the quantities of muffins and cups of coffee do not change as the
price of the muffin increases and the price of the cup of coffee decreases, as shown in
the graph.

Use the following information to solve problems 38 through 40.

Sara's income is 12 dollars per week. The price of popcorn is three dollars per bag, and the price
of cola is $1.50 per can. The figure presents Sara's preference map for popcorn and cola drinks.

Cnb loa drink)

38. How many popcorn and cola drinks does Sara buy? What is the marginal rate of
substitution at the point at which she consumes?

Sara buys 6 cola drinks and 1 bag of popcorn. Sara's marginal rate of substitution is 1/2
since the slope of Sara's budget relationship is 1/2 a bag of popcorn per cola drink.

39. Suppose that the price of cola increases to three dollars per cup, and that both the price of
rosettes and Sara's income remain unchanged. What quantities of cola drinks and popcorn
does Sara buy now? What are two points on the demand curve for Sara's cola drink? Draw
Sara's demand curve.

Sara buys 2 cola drinks and 2 popcorn. Sara buys the quantities of drinks and corn roses
that take her to the highest indifference curve, given her income and the new price of cola
and the price of corn roses.

Two points on the beverage demand curve for Sara.

Cola drinks: $3, buy 2 drinks

Cola drinks: $1.50, Sara buys 6 drinks

Its demand curve is sloping downward.

40. Suppose that the price of cola increases to three dollars per can, and that both the price of
popcorn and Sara's income remain unchanged.

a. What are the substitution effect and the income effect caused by this price change?

The substitution effect is the decrease in the quantity of cola drinks from 6 cans to 5
cans along the indifference curve = 1 can of cola.

The income effect is 3 cans of cola.

b. Is cola a normal good or an inferior good? Explain.

It is a normal good because the income effect is positive.

The economy in the news

41. Once you have analyzed Reading Between the Lines on pages 214 - 215, answer the
following questions.

to In what format do you buy your books?

.
Electronic books, since I can buy several books on a single device and I don't have to
carry them.

b. Draw your budget constraint line for books and other goods.
c.

Draw your indifference curves for books and other goods.