Microeconomics Canadian 15th Edition Ragan Solutions Manual
Microeconomics Canadian 15th Edition Ragan Solutions Manual
Microeconomics Canadian 15th Edition Ragan Solutions Manual
Part Three
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Opinions differ greatly among instructors on the amount of demand theory they wish to teach. We
have tried to accommodate both those who prefer to teach indifference curve analysis at this level
and those who prefer not to. Chapter 6 develops the theory of consumer demand using the marginal
utility approach. Though some instructors dislike using this approach (with some justification), it
does have its advantages. In particular, the discussion of marginal utility eases the presentation of
consumer surplus as well as the important distinction between total and marginal utility (such as in
the diamond-water paradox). For those instructors who prefer to use only the approach of budget
lines and indifference curves, the Appendix to Chapter 6 provides a self-contained treatment.
Indeed, these instructors can simply replace the first section of the chapter with the appendix.
Chapter 7 presents the theory of the firm in the short run, when one factor is fixed (usually
capital) and the others are variable (labour being the most prominent). We begin with a brief
discussion of firms as agents of production. We then discuss the meaning of costs, opportunity
costs, and economic profits. We also examine the difference between the various “runs” over which
firms make decisions. Profit maximization as a motivation is at the core of this chapter.
Chapter 8 discusses the choices made by firms in the long run and the very long run.
Unlike most other texts, we distinguish the period of time over which all factors are variable but
technology is fixed (the long run) from the period of time over which technology is permitted to
change (the very long run). We feel that this approach makes it easier for the student to think
clearly about firms’ choices in response to factor-price changes (long-run decisions) and firms’
choices in response to changes in technology (very long-run decisions). The Appendix to Chapter
8, analogous to that in Chapter 6, develops the theory of cost and production and long-run
substitution between labour and capital using isoquant analysis.
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This chapter is designed to cover the minimum amount of the theory of consumer behaviour
needed to read the rest of the book. The chapter is designed to be sufficient for instructors who do
not want to teach the intricacies of indifference curves to first-year students. Others may then
exercise their preference for indifference analysis by assigning the chapter’s Appendix.
***
In the first section of the chapter, we develop the theory of consumer behaviour using the marginal
utility approach. After a discussion of total utility and marginal utility, we derive the
utility-maximizing condition that the ratio of marginal utility to price be constant across all goods.
We then use that condition to derive a downward-sloping demand curve. One common pitfall for
students is to think that utility is maximized when the marginal utility for each good is equated, but
the key point, of course, is that the marginal utility per dollar spent on each good should be
equated. It is worth spending the necessary time in class to make sure that students appreciate this
distinction.
The second section contains a detailed but intuitive discussion of income and substitution
effects as a way of thinking about the negative slope of demand curves. Figure 6-3 is especially
effective at helping students understand how these different effects operate when a product’s price
changes. Though the formal treatment with indifference curves (in the Appendix) is more precise,
this intuitive discussion should be enough to allow students to use the concepts as they continue
their study of microeconomics.
The third and final section develops the idea of consumer surplus, and builds on the brief
discussion from Chapter 5. We not only develop the main idea (which is key to some of our later
discussions of allocative efficiency), but also apply this concept to an explanation of the paradox of
value (the diamond-water paradox). This is a short section, but it deserves careful attention because
the insights are of great practical importance. We find that students who have attended courses that
just take them through the equivalent of the first section of Chapter 6 tend to be critical of demand
theory as being “too theoretical”. However, students who have understood the material in this final
section tend to have some appreciation for the practical value of demand theory.
The Appendix to this chapter offers a self-contained treatment of budget lines and
indifference curves. For those instructors who prefer to use only the approach of budget lines and
indifference curves in developing basic consumer theory, the Appendix can be used in place of the
first section in the chapter. In this way you can avoid entirely the approach to consumer theory
based on the idea of diminishing marginal utility. You can then proceed from the Appendix to the
second section to emphasize the intuition behind the income and substitution effects, and then to
the final section to appreciate some applications of the core consumer theory.
Question 1
c) MUA/pA = MUB/pB
Question 2
a) The appropriate diagrams for (a) and (c) are shown below. Note that the horizontal scales for
both diagrams are the same but the vertical scales are different. Note also that marginal utility is
plotted between the integer values for the number of avocados consumed because marginal
utility measures the change in utility from consuming one more avocado.
b) The marginal utility is the change in utility divided by the change in the number of units
consumed. The marginal utilities are given in the following table:
Change in Marginal
Consumption Utility
0th to 1st 100
1st to 2nd 85
2nd to 3rd 60
3rd to 4th 40
4th to 5th 30
5th to 6th 20
6th to 7th 10
7th to 8th 5
Copyright © 2017 Pearson Canada Inc.
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Instructor’s Manual for Ragan, Economics, Fifteenth Canadian Edition
d) Brett likes avocados, and each extra avocado increases his total utility. But after some point
(and perhaps right away, as in this case), each successive avocado adds less to his total utility (or
satisfaction) than the previous one. That is, the utility that Brett gains from each extra avocado
falls. Most of us experience this phenomenon regularly, whether it be with cold beverages on a
sunny day, pieces of pizza, or meals at a nice restaurant.
Question 3
The key point here is to recognize that utility maximization requires that the marginal utility per
dollar spent on each good should be equated across both goods. If this equality does not hold,
then the pattern of expenditure can be changed in such a way as to increase total utility. Recall
also that, in the presence of declining marginal utility, an increase in the marginal utility from
consuming some product requires a reduction in the number of units of that product consumed.
The table below shows the computation of MU/p for each good and states whether consumption
of X or Y should be changed.
Question 4
In each case Luc is assumed to be maximizing his utility, so MU/P is equated across restaurant
meals and “all other goods”.
a) The MU of consuming restaurant meals is 100, so MU/P is 5. Since the price of all other
goods is $10, the MU from consuming those goods must be 50.
b) The MU from consuming all other goods is 40, so MU/P is 4. Since the price of restaurant
meals is $20, the MU from consuming restaurant meals must be 80.
c) The MU of consuming restaurant meals is 56, so MU/P is 56/20 = 2.8. Since the price of all
other goods is $10, the MU from consuming those goods must be 28.
d) The MU from consuming all other goods is 122, so MU/P is 12.2. Since the price of restaurant
meals is $20, the MU from consuming restaurant meals must be 244.
Question 5
a) From the figure, it is clear that total utility when consumption is 500 units is 75. At 600 units
it is approximately 77.5. At 700 units it also appears to be 77.5.
b) Determining the value of marginal utility at any given level of consumption requires
knowledge of the slope of the function for total utility. In order to know precisely the slope of
the function at any given point, we would have to compute the slope of a tangent line at that
point. But even without doing this we can tell that the function is steeper when consumption is
100 units than when consumption is 200 units or 500 units. So we can know for certain that
marginal utility is higher when consumption is 100 than it is when consumption is 200, which is
higher than when consumption is 500 units. The function clearly displays diminishing marginal
utility.
c) Diminishing marginal utility is shown by the fact that the slope of the function declines as the
level of consumption increases.
d) From the figure, it appears that total utility reaches a maximum when consumption reaches
600 units per period. So every extra unit of consumption beyond this point apparently does not
increase utility at all – this is the situation of marginal utility being equal to zero. This situation
is often referred to one of satiation, and is thought to be quite rare in reality.
Question 6
a) In order to maximize utility, the ratio of MU to p must be equal across all products. For each
shopping trip shown, the MU/p ratios are 0.5 for both products. So Sally is maximizing her
utility on each trip.
b) As the price of shoes declines, Sally is purchasing more shoes and this is what reduces her
MU of her consumption of shoes. (The extra utility obtained from a pair of shoes declines as the
number of pairs increases.)
c) Since the price of everything else is being held constant across the five shopping trips, it is
clear that the only exogenous variable changing is the price of shoes. Thus, we can trace out
Sally’s demand curve for shoes from the information given in the table (drawn under the ceteris
paribus assumption). As the price of shoes falls from $250 to $50 (with other prices being held
constant), Sally’s shoe purchases rise. Thus, we know that Sally’s demand curve for shoes is
downward sloping.
Question 7
a) Good X has a downward-sloping demand curve. The substitution effect of the price increase
reduces consumption, as does the income effect (which means that consumption declines and
real income falls). So Good X is a normal good.
b) Good Y has a downward-sloping demand curve. The substitution effect of the price increase
reduces consumption. But the income effect is to increase consumption as real income falls (due
to the price increase). So Good Y is an inferior good.
c) For Good X, the income effect and substitution effects are working in the same direction
(consumption falls as price rises). For Good Y, the two effects are working in the opposite
direction: the price rise leads to a reduction in consumption with the substitution effect, but an
increase in consumption for the income effect.
d) In order to be a Giffen good, the demand curve must be upward-sloping. This requires that the
income effect be opposite to and larger than the substitution effect. So, if Q1 were to the right of
Q0, Good Y would be a Giffen good.
Question 8
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 budget, and is an expense that recurs monthly.
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