Suppose that two units of X and eight units of Y give a consumer the same utility as four units of X and two units of Y. Over this range: a.
If the consumer obtains one more unit of X, how many units of Y must be given up in order to keep utility constant
∆Y∆X=2-84-2= - 62= -3
~ Utility unchanged, if consumer exchanges 3 units of Y for 1 unit of X.
If the consumer obtains one more unit of Y, how many units of X must be given up in order to keep utility constant?
∆Y∆X= 4-22-8= 26= -13
~ Utility unchanged, if consumer exchanges 1/3 units of X for 1 unit of Y.
What is the marginal rate of substitution?
X = 2, Y = 8
X = 4, Y = 2
-( 8-2 )( 2-4 )= - 62=3
Suppose a customer has indifference map shown below. The relevant budget line is LZ. The price of Y is $10.
What is the consumer’s income?
Quantity Y = 50
50 × $10 = $500
Price Y = $10
What is the price of X?
Quantity X = 40
40 × Px = 500
Price X = ?
Px = 500 / 40
Income = 500
Px = $12.50
Write the equation for the budget line LZ.
Budget line LZ
Py = $10
Px = $12.50
M = $ 500
PxX + PyY = y
12.50x + 10y = 500
y = 50 – 1.25x
What combination of X and Y will the consumer choose? Why?
Consumer choose 20 units of X and 25 unit of Y.
Indifferent curve II is tangent to budget line LZ.
No other combination costing $500 provides more utility than X = 20, Y = 25
What is the marginal rate of substitution at this combination?
MRS= PxPy= $12.50$10=1.25
Explain in terms of the MRS why the consumer would not choose combinations designated by A or B.
Combination A : MRS is the consumer can give up 1 unit of X in return for MRS more units of Y and the consumer’s utility will not change. Market prices Px and Py make the consumer can buy Px / Py ( = 1.25) more units of Y if 1 less unit of X is purchased and remain on the budget line. Slopes of the indifference curve and budget line at point A shows that Px / Py > MRS at combination A. The consumer can buy Px / Py more Y if 1 fewer unit of X is purchased, remain indifferent. Therefore, this will increase the utility, and combination A would not be chosen by the consumer.
Combination B : Consumer could trade MRS units of Y to get 1 more unit of X and the consumer’s utility would be unchanged (i.e., MRS units of Y). Since the consumer gives up less Y than the amount that would leave the consumer indiffrent, trading Px/Py units of 1 more X must increase utility, and combination B would not be chosen by the consumer.
Suppose the budget pivots to LM, money income remaining constant. What is the new price of X? What combination of X and Y is now chosen?
80 × Px = $500; thus Px = $6.25.
The consumer will choose 30 units of Y and 32 units of X
( $10 × 30) + ( $6.25 × 32 ) = $500, where the indifferent curve III is tangent to budget line LM.
What is the new MRS?
The following graph shows a portion of a consumer’s indifference map. The consumer faces the budget line LZ, and the price of X is $20.
a. The consumer’s income = $600.
30 × 20 = $600
b. The price of Y is $$20 .
c. The equition for the budget line LZ is 20X + 20Y = 600, or Y = 30 - X.
d. What combination of X and Y does the consumer choose? Why?
The consumer chooses 10X and 20Y.
e. The marginal rate of substitution for this combination is
MRS=1=PxPy= $20$20 .
f. Explain in terms of MRS why the consumer does not choose either combination A or B.
At point A, MRS > 1. The consumer is willing to give up more...
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