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Chapter 3: Q12. (page 129)

Ben allocates his lunch budget between two goods, pizza, and burritos.

a. Illustrate Ben鈥檚 optimal bundle on a graph with pizza on the horizontal axis.

b. Suppose now that pizza is taxed, causing the price to increase by 20 percent. Illustrate Ben鈥檚 new optimal bundle.

c. Suppose instead that pizza is rationed at a quantity less than Ben鈥檚 desired quantity. Illustrate Ben鈥檚 new optimal bundle.

Short Answer

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a.

b.

c.

Step by step solution

01

Ben’s optimal consumption bundle for lunch

Ben consumes pizza and burritos for lunch. His optimal consumption bundle (P1, B1) is shown in the following diagram.

The optimal consumption bundle is the point of tangency of the indifference curve with the budget line.

02

Effect of tax on Ben’s budget line

Pizza becomes costly when government taxes are imposed. Ben鈥檚 budget line will shift due to the price rise after taxes.

Ben鈥檚 optimal consumption bundle shifts to a lower indifference curve shown in the above figure. The new consumption bundle will be (P2,B2).

03

Consumer’s indifference curve during rationing

Rationing is the government鈥檚 action for controlled product distribution rather than allowing prices to increase to competitive levels.

Pizza is rationed at quantity less than the desired (Ben鈥檚 optimal consumption bundle) quantity; the indifference curve shifts downward.

The above figure shows the indifference curve, which is below Ben鈥檚 budget line. His rationed consumption bundle (P3, B3) will lie on the indifference curve below the initial indifference curve (shown in dotted lines).

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Most popular questions from this chapter

Julio receives utility from consuming food (F) and clothing (C) as given by the utility function U(F,C) = FC. In addition, the price of food is \(2 per unit, the price of clothing is \)10 per unit, and Julio's weekly income is $50.

a. What is Julio's marginal rate of substitution of food for clothing when utility is maximized? Explain.

b. Suppose instead that Julio is consuming a bundle with more food and less clothing than his utility-maximizing bundle. Would his marginal rate of substitution of food for clothing be greater than or less than your answer in part a? Explain.

Janelle and Brian each plan to spend $20,000 on the styling and gas mileage features of a new car. They can each choose all styling, all gas mileage, or some combination of the two. Janelle does not care at all about styling and wants the best gas mileage possible. Brian likes both equally and wants to spend an equal amount on each. Using indifference curves and budget lines, illustrate the choice that each person will make.

Debra usually buys a soft drink when she goes to a movie theater, where she has a choice of three sizes: the 8-ounce drink costs \(1.50, the 12-ounce drink \)2.00, and the 16-ounce drink $2.25. Describe the budget constraint that Debra faces when deciding how many ounces of the drink to purchase. (Assume that Debra can costlessly dispose of any of the soft drink that she does not want.

Consumers in Georgia pay twice as much for avocados as they do for peaches. However, avocados and peaches are the same price in California. If consumers in both states maximize utility, will the marginal rate of substitution of peaches for avocados be the same for consumers in both states? If not, which will be higher?

Connie has a monthly income of \(200 that she allocates between two goods: meat and potatoes.

a. Suppose meat costs \)4 per pound and potatoes \(2 per pound. Draw her budget constraint.

b. Suppose also that her utility function is given by the equation U(M,P) = 2M + P. What combination of meat and potatoes should she buy to maximize her utility? (Hint: Meat and potatoes are perfect substitutes.)

c. Connie's supermarket has a special promotion. If she buys 20 pounds of potatoes (at \)2 per pound), she gets the next 10 pounds for free. This offer applies only to the first 20 pounds she buys. All potatoes in excess of the first 20 pounds (excluding bonus potatoes) are still \(2 per pound. Draw her budget constraint.

d. An outbreak of potato rot raises the price of potatoes to \)4 per pound. The supermarket ends its promotion. What does her budget constraint look like now? What combination of meat and potatoes maximizes her utility?
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