Mrs. Rochester earns $4500 a week and spends her entire income on computers and pastries, since these are the only two items that provide her utility. Furthermore, Mrs. Rochester insists that for every computer she buys, she must also buy a pastry. a) What is the algebraic equation for Mrs. Rochester’s budget constraint if computers cost $25 each and pastries cost $14 each? How many of each good will she buy and represent this on a budget line with pastries on the horizontal axis. b) Draw an indifference curve showing the optimum choice. Label the optimum as point A. What would be the marginal rate of substitution at the point that corresponds to the optimal consumption choice? Interpret the marginal rate of substitution. c) Suppose the price of pastries increases to $20 and income decreases to $3200. What is the new algebraic equation for Mrs. Rochester’s budget constraint? Show the impact of the new budget line relative to the original budget line.
Mrs. Rochester earns $4500 a week and spends her entire income on computers and
pastries, since these are the only two items that provide her utility. Furthermore, Mrs.
Rochester insists that for every computer she buys, she must also buy a pastry.
a) What is the algebraic equation for Mrs. Rochester’s budget constraint if computers
cost $25 each and pastries cost $14 each? How many of each good will she buy and
represent this on a budget line with pastries on the horizontal axis.
b) Draw an indifference curve showing the optimum choice. Label the optimum as
point A. What would be the marginal rate of substitution at the point that
corresponds to the optimal consumption choice? Interpret the marginal rate of
substitution.
c) Suppose the price of pastries increases to $20 and income decreases to $3200. What
is the new algebraic equation for Mrs. Rochester’s budget constraint? Show the
impact of the new budget line relative to the original budget line.
d) What would be the new marginal rate of substitution that corresponds to the
optimal consumption choice? Interpret the marginal rate of substitution.
e) Assume for this question only that when the price of computers decreases, less of
that good is demanded. Illustrate the income and substitution effect of this price
decrease.
Step by step
Solved in 3 steps with 3 images
