Question

A recent newspaper circular advertised the following special on tires: “Buy three, get the fourth tire for free—limit one free tire per customer.” If a consumer has $360 to spend on tires and other goods and each tire usually sells for $40, how does this deal impact the consumer’s opportunity set?

Answer 1

Opportunity cost of a good is the amount of other good given up to obtain additional unit of good. Budget line explains the opportunity cost between two goods in the market.

A consumer who has $360 as income is spending on two goods that is tire and other goods. The price of tire is $40 for each tire. Suppose price of all other goods is $1. Therefore, the budget line for the consumer shows all the combinations of tires and other goods which he can consume in his income.

So the maximum tire he can purchase is 9 units with zero units of other goods or can buy 360 units of other goods with 0 units of tire. The budget line will contain all the convex combination of these two points.

The budget line for the consumer is given below:

$D:\Ani\G\12073-4-13PA.png$

Figure 1

X axis shows the quantity of tire and Y axis shows the quantities of all other goods. The downward sloping curve shows all the combinations of these two goods which consumer can purchase with his given income.

Now according to a scheme when this consumer buy three tires he will get fourth tire free and this is applicable only once. Therefore the maximum tires he can get with his income is 10 now whereas the maximum quantity of all other goods is 360 only.

The new budget line showing this situation is given below:

$D:\Ani\G\12073-4-13PA.png$

Figure 2

X axis shows the quantity of tire and Y axis shows the quantities of all other goods. The downward sloping curve shows all the combinations of these two goods which consumer can purchase with his given income. After a point at which quantity is 3, curve shifted rightwards in parallel to the previous curve because when the individual buys three tires he get fourth one free. But after that he need to pay $40 for each extra tire he buys.

The opportunity cost remains same throughout the curve except the point from where the curve has shifted. the opportunity cost of tire in terms of other goods fall at that point.