PROBLEMS & EXERCISES


SOLUTIONS & DISCUSSION

UNIT ONE (FOR EXAM ONE)

Unit One: Assignment 3: Problem 6 from pages 550-551

6. Suppose Charlie Parker CDs cost $10 each and Lester Young CDs cost $5 each. You have $40 to spend on CDs. The marginal utility that you derive from additional Charlie Parker CDs is as follows:

1st CD = 60
2nd CD = 40
3rd CD = 30
4th CD = 20
5th CD = 10

For Lester Young CDs, the figures are:

1st CD = 30
2nd CD = 28
3rd CD = 24
4th CD = 20
5th CD = 10

How many CDs of each would you buy? Suppose the price of a Lester Young CD rises to $10. How many CDs of each would you buy? Use this example to show how the principle of rational choice leads to the law of demand.

At the original prices of $10 for Charlie Parker and $5 for Lester Young, you should buy two Parker CDs and four Young CDs. Note that this would give you total utility of 202 (60 + 40 + 30 + 28 + 24 + 20) whereas buying three Parker CDs and two Young CDs would provide only 188 (60 + 40 + 30 + 30 + 28). Remember, you are trying to maximize marginal utility per dollar.

If the price of Lester Young CDs rises to $10, then you should buy three Parker CDs and one Lester Young CD. This example of rational choice illustrates the law of demand because as the price rises, you buy a smaller quantity.

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