1. For each of the following situations, decide whether the bundle Lakshani is considering optimal or not. If it is….

1. For each of the following situations, decide whether the bundle Lakshani is considering optimal or not. If it is not optimal, how could Lakshani improve her overall level of utility? That is, determine which good she should spend more on and which good should she spend less on.

a. Lakshani has $200 to spend on sneakers and sweaters. Sneakers cost $50 per pair, and sweaters cost $20 each. She is thinking about buying 2 pairs of sneakers and 5 sweaters. She tells her friend that the additional utility she would get from the second pair of sneakers is the same as the additional utility she would get from the fifth sweater.

b. Lakshani has $5 to spend on pens and pencils. Each pen costs $0.50 and each pencil costs $0.10. She is thinking about buying 6 pens and 20 pencils. The last pen would add five times as much to her total utility as the last pencil.

c. Lakshani has $50 per season to spend on tickets to football games and tickets to soccer games. Each football ticket costs $10 and each soccer ticket costs $5. She is thinking about buying 3 football tickets and 2 soccer tickets. Her marginal utility from the third football ticket is twice as much as her marginal utility from the second soccer ticket.

2. In the United States, 2007 was a bad year for growing wheat. And as wheat supply decreased, the price of wheat rose dramatically, leading to a lower quantity demanded (a movement along the demand curve). The accompanying table describes what happened to prices and the quantity of wheat demanded.

2006

2007

Quantity demand (bushels)

2.2 billion

2.0 billion

Average price (per bushel)

$3.42

$4.26

a. Using the midpoint method, calculate the price elasticity of demand for winter wheat.

b. What is the total revenue for U.S. wheat farmers in 2006 and 2007?

c. Did the bad harvest increase or decrease the total revenue of U.S. wheat farmers? How could you have predicted this from your answer to part a?

3. A recent study determined the following elasticities for Volkswagen Beetles:

Price elasticity of demand = 2

Income elasticity of demand = 1.5

The supply of Beetles is elastic. Based on this information, are the following statements true or false? Explain your reasoning.

a. A 10% increase in the price of a Beetle will reduce the quantity demanded by 20%.

b. An increase in consumer income will increase the price and quantity of Beetles sold. Since price elasticity of demand is greater than 1, total revenue will go down.

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