Answer to Question #222803 in Microeconomics for sakin

Question

A college student has two options for meals: eating at the dining hall for BDT 6 per

meal, or eating a Star Kabab for BDT 1.50 per meal. Her weekly food budget is BDT

60.

a. Draw the budget constraint showing the trade-off between dining hall meals and Star

Kabab. Assuming that she spends equal amounts on both goods, draw an indifference

curve showing the optimum choice. Label the optimum as point A.

b. Suppose the price of a Star Kabab now rises to BDT 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 her income on dining hall meals. Label the new optimum as point B.

c. What happened to the quantity of Star Kabab consumed as a result of this price change?

What does this result say about the income and substitution effects? Explain.

d. Use points A and B to draw a demand curve for Star Kabab. What is this type of good

called?

Answer 1

a)

Value of vartical intercept= food budget$\div$ price of meal at dining hall

$=\frac{60}{6}=10$

value of horizontal intercept= food budget$\div$ price of meal at Star Kabab

$=\frac{60}{1.5}=40$

BL is the budget constraint which is tanget to indifferent curve at A.

b)

When the price of a Star Kabab now rises to BDT 2, the hoirizonatl intercept will shift to$=\frac{60}{2}=30$

the budget constraint will then shift inwards as shown

the student will then spend $\frac{30}{100}\times 60=\$18$ on dining hall meals. therefore the student will consume $\frac{18}{6}=3$ dining hall meals.

c)

When price increased the quantity of Star Kabab consumed increased. The substitution effect of the rise in price will make the student consume less Star Kabab.The income effect makes the student consume more Star Kabab becauseits an inferior good.This implies income effect is negative and stronger than substitution effect.

d)

its a giffen good because it has an upward sloping curve.