The Theory of Consumer Choice 5343
43. Shelley wins $1 million in her state’s lottery. If Shelley keeps working after she wins the money,
we can infer that the substitution effect must exactly offset the income effect for her.
a. True
b. False
44. A rational person can have a negatively-sloped labor supply curve.
a. True
b. False
45. The substitution effect in the work-leisure model induces a person to work less in response to
higher wages, which tends to make the labor-supply curve slope upward.
a. True
b. False
5344 The Theory of Consumer Choice
46. The income effect in the work-leisure model induces a person to work less in response to higher
wages, which tends to make the labor-supply curve slope backward.
a. True
b. False
47. A worker with a backward-bending labor supply curve responds to an increase in wages by
working more hours.
a. True
b. False
48. A rise in the interest rate will generally result in people consuming more when they are old if the
substitution effect outweighs the income effect.
a. True
b. False
The Theory of Consumer Choice 5345
49. A rise in the interest rate will generally result in people consuming less when they are old if the
substitution effect outweighs the income effect.
a. True
b. False
50. The theory of consumer choice is representative of how consumers make decisions but is not
intended to be a literal account of the process.
a. True
b. False
5346 The Theory of Consumer Choice
51. Answer the following questions based on the table. A consumer is able to consume the following
bundles of rice and beans when the price of rice is $2 and the price of beans is $3.
RICE BEANS
12 0
6 4
0 8
a. How much is this consumer’s income?
b. Draw a budget constraint given this information. Label it B.
c. Construct a new budget constraint showing the change if the price of rice falls $1. Label this
C.
d. Given the original prices for rice ($2) and beans ($3), construct a new budget constraint if
this consumer’s income increased to $48. Label this D.
The Theory of Consumer Choice 5347
52. Draw a budget constraint that is consistent with the following prices and income.
Income = 200
PY = 50
PX = 25
a. Demonstrate how your original budget constraint would change if income increases to 500.
b. Demonstrate how your original budget constraint would change if PY decreases to 20.
c. Demonstrate how your original budget constraint would change if PX increases to 40.
5348 The Theory of Consumer Choice
53. Assume that a consumer faces the following budget constraints.
a. Assuming that income is the same on both occasions, describe the difference in relative
prices between Panel A and Panel B.
b. If income in Panel B is $126, what is the price of good X?
c. If income in Panel A is $84, what is the price of good Y?
d. Assuming that the price of good X is the same on both occasions, describe the difference in
income and price of good Y between Panel A and Panel B.
The Theory of Consumer Choice 5349
54. Evaluate the following statement, “Warren Buffet is the second richest person in the world. He
doesn’t face any constraint on his ability to purchase commodities he wants.”
55. List and briefly explain each of the four properties of indifference curves.
5350 The Theory of Consumer Choice
56. Draw indifference curves that reflect the following preferences.
a. pencils with white erasers and pencils with pink erasers
b. left shoes and right shoes
c. potatoes and rice
d. income and polluted water
The Theory of Consumer Choice 5351
57. Graphically demonstrate the conditions associated with a consumer optimum. Carefully label all
curves and axes.
58. Explain the relationship between the budget constraint and indifference curve at a consumer’s
optimum.
5352 The Theory of Consumer Choice
59. Assume that a person consumes two goods, Coke and Snickers. Use a graph to demonstrate how
the consumer adjusts his/her optimal consumption bundle when the price of Coke decreases.
Carefully label all curves and axes. What will happen to consumption if Coke is a normal good?
What will happen to consumption if Coke is an inferior good? (Remember to explain the possible
change when the income effect dominates and when the substitution effect dominates.)
The Theory of Consumer Choice 5353
60. Using the graph shown, construct a demand curve for M&M‘s given an income of $10.
5354 The Theory of Consumer Choice
61. Using indifference curves and budget constraints, graphically illustrate the substitution and income
effect that would result from a change in the price of a normal good.
62. Explain the difference between inferior and normal goods. As a developing economy experiences
increases in income (measured by GDP), what would you predict to happen to demand for inferior
goods?
The Theory of Consumer Choice 5355
63. Janet knows that she will ultimately face retirement. Assume that Janet will experience two
periods in her life, one in which she works and earns income, and one in which she is retired and
earns no income. Janet can earn $250,000 during her working period and nothing in her retirement
period. She must both save and consume in her work period and can earn 10 percent interest on
her savings.
a. Use a graph to demonstrate Janet’s budget constraint.
b. On your graph, show Janet at an optimal level of consumption in the work period equal to
$150,000. What is the implied optimal level of consumption in her retirement period?
c. Now, using your graph from part b above, demonstrate how Janet will be affected by an
increase in the interest rate on savings to 14 percent. Discuss the role of income and
substitution effects in determining whether Janet will increase, or decrease her savings in the
work period.
5356 The Theory of Consumer Choice
Problems
Scenario 21-4 Frank spends all of his income of $240 per month on shirts and hats. The price of a
shirt is $40 and the price of a hat is $30.
1. Refer to Scenario 21-4. If Frank uses all of his income to buy hats during a certain month, then
how many hats does he buy?
2. Refer to Scenario 21-4. If Frank buys 3 shirts during a certain month, then how many hats does
he buy during that month?
The Theory of Consumer Choice 5357
3. Refer to Scenario 21-4. What is the slope of Frank’s budget constraint if it is drawn with the
quantity of shirts on the horizontal axis and the quantity of hats on the vertical axis?
Figure 21-30
The graph shows two budget constraints for a consumer.
4. Refer to Figure 21-30. Suppose the consumer’s income is $90 and Budget Constraint A applies.
What is the price of a light bulb?
5358 The Theory of Consumer Choice
5. Refer to Figure 21-30. Suppose the price of a hamburger is $10 and Budget Constraint A
applies. What is the consumer’s income? What is the price of a light bulb?
6. Refer to Figure 21-30. Suppose the price of a light bulb is $3 and Budget Constraint B applies.
What is the consumer’s income? What is the price of a hamburger?
7. Refer to Figure 21-30. What particular change would result in a rotation of the budget constraint
from Budget Constraint A to Budget Constraint B?