Answer to Question #274775 in Microeconomics for pippo

Question

4. 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)

Vertical intercept:

$=\frac{60}{6}=10$ (0,10)

Horizontal intercept:

$=\frac{60}{1.5}=40$ (40,0)

BL- budget constraint

I- indifference curve.

(b)

When the price of a star kabab rises to BDT 2:

Horizontal intercept:

$=\frac{60}{2}=30$ (0,30)

The budget constraint shifts from $BL$ to $BL_1$ as shown below:

Student expenditure

$=\frac{30}{100}\times 60$ =$18.

Consumption:

$=\frac{18}{6}=3$ dinning hall meals.

(c)

When the price is increased, the quantity of Star kabab increases.

The substitution effect of the price rise will make the student consume less star kabab.

The income effect will make the student consume more star kabab because it is an inferior good.

(d)

Star kabab is a Giffen good because it has an upward sloping demand curve. Income effect dominates substitution effect and creates a situation where price and quantity demanded move in the same direction.