Answer to Question #187367 in Macroeconomics for Wesley

Question

A college student has two options for meals: eating at the dining hall for $6 per meal, or eating a Cup O’ Soup for $1.50 per meal. Hisweekly food budget is $60.

a). Draw the budget constraint showing the trade-off between dining hall meals and Cups O’ Soup. Assuming that he spends equal amounts on both goods, draw an indifference curve showing theoptimum choice. Label the optimum as point A.

b). Suppose the price of a Cup O’ Soup now rises to $2. Using your diagram from part (a), show the consequences of this change in price. Assume that our student now spends only 30 percent of his income on dining hall meals. Label the new optimum as point B.

Answer 1

(a)

Let "d" denote the number of meals consumed at dining hall and "c" be cup O' soup.

Budget constraint

=Expenditure on meals at dining hall and cup O' soup ≤ 40

$=6d+1.5c≤ 60$

Slope$=\frac{Pd}{Pc}=\frac{6}{1.5}=4$

Budget constraint$=4d+c≤ 40$

Given that half of the budget is spend on each good

$6d=\frac{1}{2}×60$

$d=5$

$1.5c=\frac{1}{2}×60$

$c=20$

(b)

The change in price decreases the intercept for meals at cup O' soup. The budget line associated with higher price is the green line shown in the graph.

It is given that 30 percent of income is spend on meals of dining halls, thus

$6d=\frac{30}{100}×60$

$d=3$

$2c=\frac{70}{100}×60$

c=21