Question

2. Many people consume eggs and toast at breakfast. Assume the typical person spends $5 per week on eggs and toast. Currently the price of eggs is $0.50 per egg, and the price of toast is $0.25 per piece.

(a) (10 points) Graph the budget constraint budget constraint.

(b) Assume that some people have a utility function given by U = min[4T, 2E] where T is the quantity of toast measured in slices, and E is the quantity of eggs.

i. (5 points) Explain the relationship between toast and eggs. Be specific.

ii. (15 points) What is the utility maximizing consumption bundle?

iii. (10 points) Add this bundle to your graph in part a with a representative indifference curve.
iv. (5 points) If income were to double, how much toast and eggs would the typical person consume?

Answer 1

(a) Pls see grapbh below. Number of eggs on vertical axis and slices of toast on horizontal axis

(b)

i. Since the utility function is min(4T, 2E), it implies that any ratio different from 1:2 between toast and egg will be inefficient. For instance, the utility from 1 toast and 2 eggs is 4, and from 2 toasts and 2 eggs is also 4, as well as from 1 toast and 3 eggs.

ii. Since the ratio of toast and eggs is fixed at 1:2, the cost of a bundle with 1 toast and 2 eggs will be $0.25+2*$0.50 = $1.25. With $5, the utility maximizing bundle will be 4 toasts and 8 eggs

iii. Pls see below

iv. If income doubles, the optimal bundle will be 8 toasts and 16 eggs.