Question

2. Many people consume eggs and toast at breakfast. Assume the typical person spends $15 per week on eggs and toast. Currently the price of eggs is $0.75 per egg, and the price of toast is $0.50 per piece.

(a) Graph the budget constraint budget constraint.

(b) Assume that some people have a utility function given by U = min[T, 2E] where T is the quantity of toast measured in slices, and E is the quantity of eggs.

i. Explain the relationship between toast and eggs. Be specific.

ii. What is the utility maximizing consumption bundle?

iii. Add this bundle to your graph in part ?? with a representative indifference curve.

iv. If income were decrease by 1/2, to $7.50, how much toast and eggs would the typical person consume?

3. What if, instead, the utility function is U=T+2E.

(a) What is the marginal rate of substitution between toast and eggs?

(b) Using the same budget constraint as question ??, what is the utility maximizing bundle of toast and eggs?

(c) If the price of toast increased to $0.75 per ounce, would the utility maximing bundle change? Explain why or why not.

PLEASE ONLY HELP WITH 3 - A, B AND C.

Answer 1

Question 3: It is a perfect substitutes utility function.

(a) MRS_TE = MUT/MUE (∂U/∂T)/(∂U/∂E) = 1/2 = 0.5

(b) Price ratio = PT/PE = 0.5/0.75 = 0.67
So, MRS < price ratio which means only eggs will be consumed.
So, Eggs = Income/PE = 15/0.75 = 20
Utility maximizing bindle is T = 0 and E = 20

(c) Price ratio = PT/PE = 0.75/0.75 = 1
So, MRS < price ratio which means only eggs will be consumed.
Thus, utility maximizing bundle will not change because relationship between MRS and price ratio does not change.