Answer to Question #298451 in Microeconomics for Mary

Question

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. Her weekly food budget is $60.

a. Draw the budget constraint showing the trade-off between dining hall meals and Cups O’

Soup. 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 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 her income on dining hall meals. Label the new optimum as point B.

c. What happened to the quantity of Cups O’ Soup 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 Cup O’ Soup. What is this type of good

called?

Answer 1

a. Draw the budget constraint:

Let d and c denote the number of meals consumed at the dining hall and cup o' Soup respectively.

Budget constraint:

Expenditure on meals at the dining hall and Cup O' Soup ≤ Income

Expenditure on meals at the dining hall (6d) + Cup O' Soup (1.5c) ≤ Income

(60)

4d + c ≤ 40

Thus, the budget constraint is 4d + c ≤ 40

lt is given that half of the budget is spent on each good. Therefore,

6d = $\frac{1}{2}$ × 60

d = 5

1.5c = $\frac{1}{2}$ × 60

c = 20

b) The change in price would decrease the intercept for meals at Coup O' Soup. The budget line associated with higher price is the green line shown in the graph:

it is given that now only 30% of income is spent on meals at dining halls. Thus

6d = $\frac{30}{100}$ × 60 = 3

2c = $\frac{70}{100}$ × 60 = 21

c) As a result of price change, consumption of meals at Cups O' Soup increased by 1. As a result t of the substitution effect, consumption should have decreased, if the consumption has increased this means that the income effect must have resulted in increasing its consumption (Meal at Cups O' Soup is inferior good as the fall in real income has resulted in an increase in its consumption) and outweighed the substitution effect.

d) The demand curve for meals at Cups O' soup would pass through (20, 1.5) and (21, 2). As the demand curve is positively sloping, a meal at Cups O' Soup is giffen good