Costs & Benefits and Marginal Analysis

Using cost-benefit analysis, a local government would decide to build a new bridge if

• The additional tax paid by an individual resident is greater than the additional benefit of building the bridge for all residents.

• The toll paid by an individual resident crossing the bridge is less than the resident’s benefit from crossing the bridge.

• The total costs of building the bridge are less than the total benefits from building the bridge.

• The total costs of building the bridge are greater than the total benefits from building the bridge.

• Total costs are at a minimum and total benefits are at a maximum.

According to the theory of consumer behavior, which of the following decreases first as additional units of a product are consumed?

• Total utility

• Average utility

• Marginal utility

• Marginal physical product

• Total physical product

An opportunity cost is entailed in which of the following situations?

I. A student decides to attend college full-time.

II. A family uses its $20,000 savings to purchase an automobile.

III. A farmer decides to grow more wheat and less corn.

• I only

• II only

• III only

• I and III only

• I, II, and III

Assume a worker can either cut grass or wash windows in a given day. It takes 5 hours to mow a one-acre lawn and 2.5 hours to wash all the windows in a house. When a worker chooses to wash the windows of four houses in a neighborhood, what is the opportunity cost of this decision?

• The pay the worker receives for washing the windows in the four houses

• The pay the worker would receive for cutting one lawn

• Cutting the grass at the same four houses

• The pay the worker would have received from cutting the grass at two houses

• The pay the worker would receive for cutting .25 lawns

Answer explanation

The opportunity cost of washing windows is the next-best alternative the worker has given up to wash windows. If it takes 5 hours to mow the one-acre lawn and 2.5 hours to wash the windows, the opportunity cost of mowing one lawn is washing the windows of two houses; the opportunity cost of washing the windows of one house is mowing .5 lawns. Thus, in washing the windows of four houses the worker is expending 10 hours, the time in which he could cut two lawns; or 4 houses multiplied by .5 lawns equals two lawns and the pay that he would have earned.

When total utility is at its maximum, marginal utility is

• increasing

• negative

• equal to zero

• at a maximum

• at minimum

At her current level of consumption, a consumer is willing to pay up to $1.50 for a bottle of water and up to $1,500 for a diamond ring because the

• total utility of diamond rings is greater than the total utility of water

• total utility of water is less than the marginal utility of a diamond ring

• marginal utility of a bottle of water is less than the marginal utility of a diamond ring

• marginal utility of a bottle of water is greater than the marginal utility of a diamond ring

• consumer is irrational and does not understand that water is more important than a diamond

• Widening existing highways

• Building new highways

• Building a new bridge

• Building a new tunnel

• Expanding an existing airport

Assume a consumer is spending all her income on two goods: X and Y. At the current consumption combination of the two goods, if the marginal utility per dollar spent on the last unit of good X exceeds that of the marginal utility per dollar spent on the last unit of good Y, what should the consumer do to maximize utility?

• Purchase more units of X and more units of Y.

• Decrease the price of good X.

• Purchase more units of X and less units of Y.

• Increase income to buy more of both good Y and good X.

• Nothing; utility is maximized at current consumption bundles.

Answer explanation

To maximize utility, consumers must allocate their income so that the marginal utility per dollar spent on the last unit of each good is equal. With the marginal utility per dollar of good X greater than that of good Y, the consumer should take a dollar that is being spent on Y and use it to buy a dollar more of X. The consumer should continue the substitution of X for Y until both goods provide the same marginal utility per dollar spent. Doing so will raise total utility.

Assume the price of a candy bar is $2 and the price of a bag of chips is $3. Assume Lilly’s marginal utility from consuming an additional candy bar is 10 utils and her marginal utility from consuming an additional bag of chips is 12 utils. If Lilly is spending her fixed weekly allowance on candy bars and bags of chips, which of the following actions will maximize Lilly’s total utility?

• Buying more candy bars and bags of chips

• Buying more candy bars and fewer bags of chips

• Buying fewer candy bars and more bags of chips

• Buying fewer candy bars and bags of chips

• Buying the same number of candy bars and bags of chips

Answer explanation

To maximize utility, Lilly must allocate her income so that the marginal utility per dollar spent on the last unit of each good is equal. The marginal utility per dollar spent on the last candy bar is 5 utils per dollar (10 utils divided by $2), and the marginal utility per dollar spent on the last bag of chips is 4 utils per dollar (12 utils divided by $3). Given Lilly’s fixed weekly allowance, Lilly should buy more candy bars and fewer bags of chips.

Garcia is currently spending his entire lunch budget on 3 sodas and 4 hot dogs. At his current level of consumption, Garcia’s marginal utility for sodas is 5 utils and his marginal utility for hot dogs is 10 utils. In order to maximize his total utility, Garcia should

• consume more sodas and fewer hot dogs regardless of the prices

• consume more hot dogs and fewer sodas regardless of the prices

• maintain his current level of consumption of sodas and hot dogs regardless of the prices

• maintain his current level of consumption if the price of a soda is $1 and the price of a hot dog is $2

• maintain his current level of consumption if the price of a soda is $2 and the price of a hot dog is $1