Test Questions with Answers
Chapter 8. Demand Theory I.
The Demand Curve. Consumer Behaviour
Chapter 8 ―Question 1
Below you find a demand schedule for ice cream cones for June, July and August. A, B and C are three different consumers.
| Price | A | B | C |
| $2 | 40 | 30 | 10 |
| $3 | 30 | 22 | 8 |
| $4 | 20 | 18 | 2 |
1) Draw a market demand curve for ice cream cones.
2) The current market price is $3. What is market demand at this price?
3) Show on your diagram what happens to the market demand curve when market demand declines by 20 percent owing to cold, rainy weather.
*1) Here is the schedule:
| y | x |
| $2 | 80 |
| $3 | 60 |
| $4 | 40 |
*2) 60 units
*3) The curve shifts to the left. Textbooks always illustrate changes in demand with the help of a parallel shift of the demand curve. It is noteworthy that a 20-percent decline in demand does not lead to a parallel shift.
Chapter 8 ― Question 2
A household earns $5,000 a month and saves $1,000 a month. What is its propensity to consume?
| * 0. 2. | Consumption | 1,000 = 0.2 | ||
| Income | 5,000 |
Chapter 8 ― Question 3
What is the propensity to consume of a household
1) that spends its entire income
2) that saves its entire income
*1) 1
*2) 0
Chapter 8 ― Question 4
Below you find the utility a consumer derives from buying three commodities A, B and C.
| Product | A | B | C |
| Quantity | 2 | 3 | 4 |
| Price per unit | $5 | $7 | $9 |
| Utility derived from the last unit | 10 utils | 10 utils | 10 utils |
The consumer
- has made a rational decision because all three products yield the same marginal utility
- should decrease purchases of C
- should decrease purchases of A and B and increase purchases of C
- should increase purchases of A
*D. Answer A is a trap. The marginal utility alone is not relevant. What counts is MU/P. This is highest for Commodity A. Remember the rule: You should increase consumption of the commodity whose MU/P has the highest value.
Chapter 8 ― Question 5
The slope of the demand curve for butter shows that an increase in the price of butter leads to
- a decline in the amount of butter available
- an increase in demand for margarine
- an expected decline in the price of butter
- a decline in the price of margarine
*B. When butter becomes more expensive, some consumers switch to margarine. As a result, quantity demanded of butter declines, which is reflected by the slope of the demand curve.
Chapter 8 ― Question 6
Refer to the table below. What is the utility derived from increasing consumption from 3 ice cream cones to 4 ice cream cones?
| Number of Ice Cream Cones | Total Utility | Marginal Utility | ||
| 1 | 15 | |||
| 2 | 5 | |||
| 3 | 0 | |||
| 4 | 18 |
* Minus 2. Total utility from 2 ice cream cones is 20, from 3 ice cream cones it is also 20.
Chapter 8 ― Question 7
A consumer buys a bundle of two goods, A and B. MU/P for A is 40/1. The marginal utility of B is 20. The price of B must therefore be
- 5
- 0.5
- 2
- none of the above
*B. The ratio 40/1 for A is the same as 20/0.5 for B.
Chapter 8 ― Question 8
A consumer buys a bundle with two goods, X and Y. MU/P for X is 4, MU/P for Y is 3. What should the consumer do to optimise his decision with the same amount of money?
- increase X
- increase Y
- increase Y and lower X
- increase X and lower Y
*D. Always increase consumption of the commodity whose MU/P has a higher value. Answer A is not correct because, if the amount of money remains the same, the consumer must lower Y to increase X.
Chapter 8 ― Question 9
Explain the relationship between the income and substitution effects.
* The income effect results from a change in the price of a commodity; it is a change in purchasing power. It is followed by the substitution effect if (1) there is a substitute and (2) one of the commodities is now cheaper and is hence substituted for the more expensive one.
Chapter 8 ― Question 10
Explain why the law of diminishing marginal utility is the best explanation of the law of demand.
* Diminishing marginal utility must be matched by declining prices, otherwise no additional units will be bought.
Chapter 8 ― Question 11
An increase in the propensity to consume will
- cause a movement downward the demand curve for red roses
- cause a movement upward the demand curve for red roses
- shift the demand curve for red roses to the right
- shift the demand curve for red roses to the left
*C. An increase in the propensity to consume has the same effect as an increase in incomes; it shifts the demand curve to the right. Answers A and B are wrong because there is no change in the price of red roses. Answer D is wrong because a shift to the left means that fewer red roses are bought.
Chapter 8 ― Question 12
A decline in incomes will
- shift the demand curve for hamburgers to the left
- shift the demand curve for hamburgers to the right
- cause an upward movement along the demand curve for hamburgers
- cause a downward movement along the demand curve for hamburgers
*B. Hamburgers are an inferior good. As incomes decline and many people can no longer afford expensive foodstuffs, more hamburgers will be bought. As income is an exogenous variable, the curve shifts.
Chapter 8 ― Question 13
If the price of one product is lowered, the substitution effect suggests that consumers will buy more of the product whose price has not changed. True or false? Explain your answer.
* False. Consumers want to buy more of the good that is cheaper, which can be the one whose price has been lowered or the one whose price has not changed.
Chapter 8 ― Question 14
Many people think that junk food is an inferior good. If consumer incomes increase, what happens to
1) the demand curve for junk food
2) the quantity demanded
3) the equilibrium price
*1) The demand curve shifts to the left. Less junk food is bought at constant prices.
*2) The quantity demanded falls. The new equilibrium is the intersection of the shifted demand curve and the supply curve.
*3) The equilibrium price falls. The new equilibrium is at a lower point than the old one.
For questions of this kind, it is best to sketch the graph.
Chapter 8 ― Question 15
Look at the table below.
| Commodity A | Commodity B | |
| MU | 40 | 20 |
| Price | 8 | 5 |
A consumer's expenditure is given. He could improve his choice by
- consuming A only.
- consuming B only
- increasing consumption of A and reducing consumption of B
- increasing consumption of B and reducing consumption of A
*C. MU/P for A is 5. MU/P for B is 4. The consumer should therefore increase consumption of A.
As his budget is given, he must simultaneously reduce B.
Chapter 8 ― Question 16
Your optimal buying decision is to buy 20 units of A at $1 and 5 units of B. The last A gave you 10 units of utility. The last unit of B gave you 20 units of utility. The price of B is
- $0.50
- $0.25
- $4.00
- $2.00
*D. MU/P for A is 10/1. MU/P for B is 20/? The price of B must therefore be $2.00. The trap in this question is that the total numbers of units are indicated. They are irrelevant to the answer.
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