Answer to Question #316613 in Microeconomics for Yan

Question

Problem 2. Amy has $20 a week to spend on coffee and coke. The price of coffee is $4 a cup, and the price of cake is $2 a slice.

 

1.     Calculate Amy’s real income in terms of cake, calculate the relative price of cake in terms of coffee.

2.     Calculate the equation for Amy’s budget line (with cups of coffee on the left side).

3.     If the price of cake doubles while the price of coffee remains at $4 a cup and Amy’s income remains at $20, describe the change in her budget line.

Answer 1

1) Amy's real income in terms of cake is $20/($2 per slice), which is 10 slices. The relative price of cake in terms of coffee is ($2 per slice)/($4 per cup) = 0.5 cups of coffee per slice of cake.

2)

Let Y represent Coffee and X represent Cake

Budget line;

4Y+2X= 20

3) If the price of cake doubles

The position of the budget line shifts inwards while remaining constant on the vertical axis as shown below. This is because Amy can afford less of the cake due to reduced real income in terms of cake.