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ECON 3310 – Microeconomics Fall 2020 – David Quigley

Group Report 2 – Due Monday, Mar. 29th

Write a minimum of 4 pages, double-spaced, answering the questions below. If you include figures, those count towards the page minimum. Be as specific as possible and always include explanations that describe your reasoning.

Suppose you’re writing a report for state legislators on the economic situation facing consumers. The state legislators would like the following questions answered so that they can better understand consumer behavior and the impact of potential policies on the state economy.

1. Consumer purchasing behavior is driven by consumer preferences. The state legislators would like to better understand consumer preferences and the requirements needed to analyze consumer preferences. What does restricting consumer preferences to be transitive mean, and what are the implications of transitivity for consumer indifference curves?

a. What does the Diminishing Marginal Rate of Substitution mean, and what are the implications of a Diminishing Marginal Rate of Substitution for consumer indifference curves?

b. What is the relationship between the Diminishing Marginal Rate of Substitution and the Law of Diminishing Marginal Utility?

2. Consumer budgets are likely to be impacted by changes in market conditions. Along

those lines, how do the prices of products factor into the slope of a consumer’s budget line?

a. Suppose writing utensils are on the x-axis of the graph for the budget line and salty snacks are on the y-axis. If the price of writing utensils increases, how does this impact the budget line?

b. If consumers’ budgets for writing utensils and salty snacks decreases, how does this impact the budget line?

c. Explain how a gift certificate for writing utensils would impact a consumer’s budget line in comparison to a cash gift.

3. The state legislators recognize that consumer demand is determine by the Utility Maximizing point, but are unsure of how the Utility Maximizing point is found. Explain the relationship between the budget line and an indifference curve at the Utility Maximizing point and how tangency between two curves factors into this.

4. Now state legislators want to make predictions about how changes in consumers’ budgets will impact their consumption behavior. If writing utensils and salty snacks are both normal goods with writing utensils on the x-axis of the graph and salty snacks on the y-axis, explain how a decrease in consumers’ budgets would impact the consumption of writing utensils and salty snacks.

a. Suppose instead that state legislators think writing utensils are an inferior good. If consumers’ budgets decrease, explain what would happen to the consumption of both writing utensils and salty snacks.

b. Can writing utensils be an inferior good at all budget levels? What might the relationship between budget and consumption of writing utensils look like?

c. If the state legislature is considering giving people gift certificates for writing

utensils what considerations about the impact of gift certificates on people’s utility should they understand in comparison to an equivalent cash gift?

5. State legislators recognize that a change in the price of writing utensils has both a substitution effect and an income effect. How are the substitution effect and income effect different from each other? If writing utensils are an inferior good and the price of writing utensils increases, how does this impact the substitution effect and the income effect? What are the potential implications for the total effect of the price increase?