marginal rate of substitution, budget constraint, specific question help
marginal rate of substitution, budget constraint, specific question help
Kim has an income of $100 a week and is observed consuming 5 sushi dinners at $15 per dinner and 10 ice cream sodas at $2.50 each. Through a series of questions we determine that her marginal rate of substitution for this consumption choice is 7.
- Explain why Kim isn’t maximizing her utility. To maximize utility should she increase (or decrease) her consumption of ice cream sodas? Sushi?[1] Illustrate your answer using a graph (put ice cream sodas on the X-axis and sushi on the Y-axis and assume that Kim has convex indifference curves).
- For this part of the question assume that Kim starts off at a combination of ice cream sodas and sushi that maximizes her utility given the prices and income level given above. Illustrate this starting point in a graph with indifference curves and budget constraints. Suppose the price of an ice cream soda increases to $4 each. Illustrate how Kim’s consumption changes in your graph. Show your answer by illustrating the substitution and income effects in your graph. Assume that ice cream sodas are a normal good. Explain.
[1] You can’t solve for the “exact” optimal solution. A general description of what she should do is fine.
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