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BUS 207 Chapter Notes - Chapter 6: Jeans, Shortage, Durable GoodExam

Business Administration
Course Code
BUS 207
Bernie Maroney
Study Guide

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Chapter 6: Consumer Behaviour
Answers to Study Exercises
Fill-in-the-Blank Questions
Question 1
a) utility (or satisfaction); diminishes
b) marginal utility; equalized
c) MUA/pA = MUB/pB
d) negative
e) increases; ski passes; golf games
f) 50
g) quantity demanded; negatively sloped
Question 2
a) price; constant
b) real income; constant
c) same; reduction
d) opposite; reduction; increase
e) substitution; income; income; substitution
Question 3
a) below; above; price that is actually paid
b) greater than
c) zero
d) $14
e) very low (close to zero); very high
f) high; low

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Review Questions
Question 4
a) Since salt is a very small element in most people’s consumption bundle, the income effect is
likely to be very small, such that a 10% increase in price should have very little effect on the
quantity demanded. Also, note that there are few good substitutes for salt, so demand tends to be
relatively inelastic.
b) Blue jeans are relatively expensive purchases, and due to swings in fashion may not be that
durable. Therefore, one might expect the income effect to be reasonably large, such that an increase
in price is likely to elicit a reasonably large change in consumption. This is compounded by the fact
that many people might view a large class of clothing as good substitutes for blue jeans, thus
making the demand for jeans relatively elastic.
c) Even the total of all fruits and vegetables makes up a relatively small portion of the average
consumer’s consumption bundle. This implies a small income effect and, for this reason, demand is
likely to be quite inelastic. In addition, there are not many good substitutes to “all fruits and
vegetables”, another reason demand is likely to be inelastic.
d) While gasoline consumes a significant portion of many people’s income, implying a large
income effect, there are few viable substitutes. Consequently, gasoline may exhibit significant
response to price increases, but smaller than one might expect from the pure income effect.
e) Mini-vans are extremely large purchases and should possess very large income effects. Further,
as a consumer durable, mini-vans may be repaired instead of replaced. Consequently, quantity
demanded for mini-vans should exhibit very large responses to changes in price. Working in the
same direction, large sedans and sport utility vehicles are, for many consumers, reasonably good
substitutes for mini-vans, making demand even more elastic.
f) The income effect from a change in rent for apartments is probably bigger than for most products
since rent makes up a large portion of most people’s monthly budget and recurs every month.
g) Luxury cars are expensive and will constitute a significant portion of the consumer’s income,
except for very rich consumers. The income effect is therefore likely to be significant, making
demand relatively elastic. However, available substitutes are limited, especially if the luxury car is
purchased to confer status and prestige, rather than just being a means of comfortable
transportation. In the final analysis, it is probably best to segment the groups of consumers between
the very rich and the not so rich. Demand among the first group is probably very inelastic; demand
among the second group is probably quite elastic.
h) Most electronic equipment (TVs, laptops, tablets, smart phones, etc.) are durable goods they
last for a year or two, and sometimes much longer. This durability means that we do not buy them

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on a regular basis, and the price of the product gets “spread out” over the life of the product. So, the
average monthly expenditure on electronic products is relatively small as a fraction of total monthly
expenditures, making the income effect from a price change relatively small.
i) A one-week, all-inclusive vacation to Cuba might cost anywhere between $700 and $5000
depending on where you live and the quality of the resort that you visit. For most people, this
amount represents a significant share of monthly income, and so a 10% price increase is likely to
have a significant effect on quantity demanded. On the other hand, these vacations are typically
taken only every few years, and so the price of the vacation is a much smaller share of the total
income over the larger period. Also, there are lots of substitute places to vacation, so demand will
be elastic.
j) The fee for a one-day car rental is a relatively small share of most people’s monthly income. And
since most people rent a car only occasionally, a 10% price increase is unlikely to have a large
effect on car rentals. So demand will be relatively inelastic. However, for people who rent cars
frequently, the income effect from a price increase will be larger.
Question 5
For most products, the substitution effect of a price change is always in the direction of
increasing quantity demanded when the price falls (or reducing quantity demanded when the
price rises). (In the extreme case where products are viewed by the consumer as being perfect
complements, sometimes called Leontief preferences, the substitution effect is precisely zero.)
The direction of the income effect depends on whether the good is normal or inferior. For a
normal good, the income effect of a reduction in price is to increase real purchasing power and to
increase quantity demanded; for an inferior good, the income effect of a reduction in price is to
increase real purchasing power but to reduce quantity demanded. (The quantity demanded for
inferior goods increases when income falls.)
Putting the substitution and income effects together, we have:
Normal goods: Income and substitution effects work in the same direction
Inferior goods: Income and substitution effects work in the opposite direction.
This is why, as shown in Figure 6-2, the demand curve for a product will only be upward sloping
in the rare case where that product is “strongly inferior”, meaning that the income effect
outweighs the substitution effect. This is the case of a Giffen good.
Question 6
a) Consumer surplus at price p0 is given by the triangle defined by points BCD.
b) The new equilibrium price is p1 and quantity is Q1. Consumer surplus is now given by the
triangle ACE.
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