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Suggested solutions to Assignment

Question 1

“Without the postulate of substitution, there is no law of demand.”   Do you agree?  Explain.                                                                                                                (10 marks)

Answer

Yes, I agree.
The law of demand states that if the price of a good increases, its quantity demanded will decrease, and vice versa, ceteris paribus.  If there is no postulate of substitution, people will never give up the quantity of a good even they have to pay a much higher price, rendering the law of demand to be invalid.

Question 2

Marginal use value curve of an individual on a good is his demand curve of the good.  Why?                                                                                                                (10 marks)

Answer

Marginal use value is defined as the maximum amount an individual is willing to pay for an extra unit of a good.  It is postulated that the more one has, the lower is his marginal use value.

An individual will buy more of a good if his marginal use value is higher than the price of the good i.e. what he is willing to pay for that extra unit of good is more than what he actually pays for it.  Conversely, he will consume less of the good if his marginal use value on the good is lower than its price.  Hence the quantity demanded of a good by an individual at a particular price will be at a point where price is equated to marginal use value:














That is to say, the marginal use value curve shows the relationship between price and quantity demanded of a good.  Marginal use value is thus the individual’s demand curve.

Question 3

Couples with babies have to employ baby-sitters if they want to leave home without their babies.  It is observed that these couples often go to more expensive restaurants than those who have no children.  Explain the phenomenon by using the law of demand.                                                                                                                (10 marks)

Answer

Suppose the cost of employing a baby-sitter is T and the costs of dining in a more expensive restaurant and that of dining in a less expensive restaurant are C1 and C2 respectively.  Obviously C1 > C2.

Then for couples without children, their relative price to dine in a more expensive restaurant (in terms of that of a less expensive restaurant) is C1/C2.  The relative price for couples with children to dine in a more expensive restaurant is (C1+T)/(C2+T), which is lower than C1/C2.  Hence a greater proportion of couples with children will dine in more expensive restaurants.

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