Chad is willing to pay $5.00 to get his first cup of morning latté; he is willing to pay $4.50 for a second cup. He buys his first cup from a vendor selling latté for $3.75 per cup. He returns to that vendor later in the morning to find that the vendor has increased her price to $3.90 per cup. Chad buys a second cup. Which of the following statements is correct? a. Chad’s consumer surplus on his second cup of latté was larger than his consumer surplus on his first cup of latté. b. Chad places a higher value on his second cup of latté than on his first cup of latté. c. Chad’s willingness to pay for his second cup of latté was smaller than his willingness to pay for his first cup of latté. d. Chad is irrational in that he is willing to pay a different price for his second cup of latté than what he is willing to pay for his first cup of latté.

C. Chad's willingness to pay for his second cup of latte was smaller than his willingness to pay for his first cup of latte.

Explanation:

Consumer surplus refers to the excess of price a consumer is willing to pay for a good over the price he actually ends up paying.

In the given case, Chad was willing to pay $5 for his first cup of latte. He bought the first cup for $3.75.

Thus, his consumer surplus for the first cup he purchased = $5 - $3.75

                                                                                          = $1.25

Similarly, his consumer surplus for the second cup of latte he purchased being,                                                                                 = $4.5 - $3.90

                                                                                          = $0.6

As can be seen, his consumer surplus has fallen in case of the second cup and also by the concept of diminishing marginal utility by which utility derived after each successive unit of consumption falls, Chad was willing to pay lesser i.e $4.5 instead of $5 for the second cup of latte.

Hence, Chad's willingness to pay for his second cup of latte was smaller than his willingness to pay for his first cup.

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