Multiple Choice
As Caffeinated Carl consumes additional cups of coffee, his
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18. Consumer Choice and Behavioral Economics
Consumer Optimum Consumption: Marginal Utility per Dollar Spent
Multiple Choice
How would a coupon for coffee affect consumer choices differently than a cash transfer?
A
A coupon is an in-kind subsidy that lowers the effective price of coffee and induces more coffee consumption than an equivalent cash transfer, while a cash transfer raises overall purchasing power so consumers reallocate spending to equalize marginal utility per dollar across goods.
B
A coupon for coffee reduces the marginal utility of coffee so much that consumers end up buying less coffee than they would with a cash transfer.
C
A coupon and a cash transfer are equivalent because both increase real income by the same monetary amount, so consumers will adjust consumption in the same way.
D
A coupon forces consumers to purchase a fixed quantity of coffee and therefore has no effect on marginal utility per dollar, whereas a cash transfer changes relative prices and choices.
Verified step by step guidance1
Understand the difference between a coupon and a cash transfer: a coupon is an in-kind subsidy that specifically lowers the effective price of a particular good (coffee), while a cash transfer increases the consumer's overall income without restricting how it is spent.
Recall that consumers maximize utility by allocating their budget so that the marginal utility per dollar spent is equalized across all goods. This is expressed as \(\frac{MU_x}{P_x} = \frac{MU_y}{P_y}\), where \(MU\) is marginal utility and \(P\) is price for goods \(x\) and \(y\).
Analyze how a coupon affects consumer choice: since the coupon lowers the effective price of coffee, the ratio \(\frac{MU_{coffee}}{P_{coffee}}\) increases, encouraging consumers to buy more coffee relative to other goods.
Analyze how a cash transfer affects consumer choice: the consumer's budget constraint shifts outward, increasing overall purchasing power. Consumers then reallocate spending to equalize marginal utility per dollar across all goods, which may increase consumption of coffee but also other goods.
Conclude that a coupon leads to more coffee consumption than an equivalent cash transfer because it changes relative prices directly, while a cash transfer changes overall income and allows consumers to optimize consumption across all goods.
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