chp 5 instructor manual

chp 5 instructor manual - Chapter 5 DEMAND ANALYSIS AND...

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Chapter 5 DEMAND ANALYSIS AND ESTIMATION Q5.1 "The utility derived from consumption is intangible and unobservable. Therefore, the utility concept has no practical value.” Discuss this statement. Q5.1 ANSWER The utility derived from consumption is intangible, and therefore unobservable. However, when goods and services provide utility to consumers, there is a direct and measurable influence on their purchase decisions. Through their revealed preferences, consumers convey their evaluation of the value, or worth, of individual products. While the value derived through consumption is intangible, it leads to purchase decisions that can be monitored and responded to by firms. Q5.2 Is an increase in total utility or satisfaction following an increase in income consistent with the law of diminishing marginal utility? Q5.2 ANSWER Yes, the law of diminishing marginal utility states that the marginal utility derived from consumption will eventually diminish as consumption increases during a given time period. This means that the addition to total utility per dollar of income will tend to fall as total income rises. Despite the fact that total utility, or well-being, tends to rise with income, it is typical that the marginal utility derived per dollar of income tends to fall as income rises -- as is predicted by the law of diminishing marginal utility. Q5.3 Prospective car buyers are sometimes confronted by sales representatives who argue that they can offer a vehicle that is “just as good as a BMW, but at one-half the price.” Use the indifference concept to explain why the claims of the sales representative are not credible. Q5.3 ANSWER If two products provide the same amount of satisfaction or utility, the consumer is said to display indifference between the two. Indifference implies equivalence in the eyes of the consumer. A consumer can be indifferent between goods and services that are distinct in a physical or material sense. Similarly, a consumer can display distinctly different preferences for goods and services that are similar in a physical or
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104 Chapter 5 material sense. What’s important in the case of consumer indifference is that two products yield the same amount of satisfaction or well-being to the consumer. This should make consumers skeptical of sales representatives who argue that a cheaper product is “just as good as” a more expensive competitor. First of all, cheaper substitutes seldom perform at the same high level as competing products with a deservedly superior reputation. And second, it is important to remember that when consumers buy a product, they purchase a whole range of attributes associated with that product. For example, the BMW 760i four-door sedan is a $125,000 vehicle famous among car buffs for its awesome power, comfort, and styling . Buyers of a BMW 760i four-door sedan not only enjoy the creature comforts of a
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  • Summer '10
  • LEITER
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chp 5 instructor manual - Chapter 5 DEMAND ANALYSIS AND...

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