Question

Refer to the graph below for the questions 2a-2f). Wolfie consumes pizza and soda and the graph illustrates his indifference curves. 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 Pizza 2. a) Suppose Wolfie has an income of $24, that Ppizza = $2, and that Psoda = $2. Draw Wolfies budget constraint in the above figure. What is the opportunity cost of one more slice of pizza? b) At this income and prices, what is the optimal consumption bundle for Wolfie? c) Suppose the price of pizza falls to Ppizza = $1. Draw the new budget constraint. The fall in the price of pizza causes the quantity demanded of pizza to increase by how many units? d) (Fill in blanks) Go back to the case where Ppizza = $2, and that Psoda = $2 and where Wolfie has an income of $24. Now suppose that income doubles to $48. Draw in the new budget constraint and determine the new optimal consumption bundle. By comparing consumption when income is $24, to consumption when income is $48, we can see that pizza is a (normal/inferior) - good and soda is a normal/inferior) — good. e) Wolfie's preferences are an example of the case of perfect substitutes. Is this statement True or False?

Answer 1

a) Wolfie's income = $24, P_pizza = $2 and P_soda = $2.

Then, Wolfie can purchase 12 slices of pizza or 12 bottles of soda. Thus, the budget constraint will have vertical and horizontal intercepts of 12 each.

b) At this budget constraint, consumption will be 8 slices of pizza and 4 bottles of soda (at the point where indifference curve and budget constraint touches each other).

c) If Wolfie's income = $24, P_pizza = $1 and P_soda = $2.

Then, Wolfie can purchase 24 slices of pizza or 12 bottles of soda. Thus, the budget constraint will have vertical and horizontal intercepts of 12 and 24 respectively.

Then, at this budget constraint, consumption will be 12 slices of pizza and 6 bottles of soda (at the point where new indifference curve and new budget constraint touches each other).

d) If income doubles to $48, Wolfie can buy 24 slices of pizza or 24 bottles of soda. Thus, the new budget constraint has vertical and horizontal intercepts of 24 each.

As a result, a new indifference curve touches the new budget constraint at the consumption level of 16 slices of pizza and 8 bottles of soda.

As consumption of pizza and soda increases with increase in income, pizza and soda are normal good.

e) L shaped indifference curves represent perfect complements. Thus, the given statement is incorrect.