Question

Homer consumes only donuts and beer. When he consumes less than 10 beers, Homer would gladly drink one more. After drinking 10 beers, Homer is so drunk that he does not notice any additional bottle he drinks (that is, the benefit of an additional bottle of beer is zero). Drinking more than 17 beers is beyond the processing capability of Homer’s liver and any additional bottle makes him sick (beer is no longer a “good” for Homer). Homer’s preferences for donuts are somewhat similar. As long as he eats less than 15 donuts, an additional donut increases his utility. If he eats more than 15 donuts, then additional donuts make him worse off.

a/ Sketch Homer’s indifference curve passing through point (8 donuts, 8 beers).

b/ Sketch Homer’s indifference curve passing through point (15 donuts, 16 beers)

Hint 1: Homer does not have “standard” indifference curves. That is, his indifference curves could be downward or upward sloping, convex, or concave, or only locally convex or concave. Hint 2: For each of the above questions, it is possible to (and you should!) sketch Homer’s entire indifference curves.

Homer consumes beer and donuts. Beer is an inferior good. One day the price of donuts falls.

c/ Use a graph (measuring quantity of donuts on the horizontal axis) to show what happens to the budget line.

d/ Show the substitution and income effect of the change of the price of donuts on Homer’s beer consumption. Explain how does your diagram show that beer is an inferior good.

e/ Does Homer end up drinking more or less beer than before? Justify your answer carefully.

Answer 1

a) Homer’s indifference curve passing through point (8 donuts, 8 beers):

b) Homer’s indifference curve passing through point (15 donuts, 16 beers):

c) Effect of fall in the price of donuts on the budget line.

d) Substitution and Income effect of the change of the price of donuts on Homer’s beer consumption.

of the change of the price of donuts on Homer’s beer consumption.

The diagram show that beer is an inferior good because of high substitution effect and direct price and income effect.