Question

Remy spends her weekly income of $30 on chocolate (C) and shampoo
(S). Initially, when the prices are pC = pS = 2, she consumed the bundle: (C, S) = (10, 5). After
prices change to pC = 1 and pS = 3, she purchases the bundle (C, S) = (6, 8).
(a) Draw Remy’s budget line and indicate her original bundle of goods.
(b) On a new diagram or the same one above, draw Remy’s new budget line and
indicate her new bundle of goods.

(c) Use a revealed preference argument to discuss whether or not Remy has maxi-
mized her utility before and after the price changes.

Answer 1

(c) Remy has not maximized her utility after the price change.

Initially she was consuming (10,5) and after the price change, she chooses bundle (6,8). As we can see from the figure given original prices bundle (6,8) was affordable but she chose not to consume it at that time rather preferred a bundle on budget line giving higher utility.

This shows when (6,8) was affordable before price change, she preferred (10,5) over (6,8). If after price change, she chooses (6,8) it will reduce her utility. After price change any point on and inside the region CEB will not maximize her utility. Points on ED will maximize her utility after price change.