# Long Assignment 3 Answer Key - ECON 256 Intermediate...

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ECON 256: Intermediate Microeconomics Long Assignment: 3 1 Answer Key Due Date: Thursday, October 21, 2010 1. Marilyn spends her entire monthly income of \$600 on champagne (C) and perfume (F). The price of a bottle of champagne is \$30 and the price of an ounce of perfume is \$10. If she consumes 12 bottles of champagne and 24 ounces of perfume, her MRS CF is 1. Is her choice optimal? If yes, mention why. If not, explain what she ought to change in her consumption. Explain your answer with a diagram labeling everything clearly. The budget constraint has a slope of -3. To put it another way, the ratio of the prices of the goods on the X and Y axis is 3. So for optimal consumption, Marilyn should consume a bundle that generates MRS of Perfume for Champagne of 3. At her current consumption point B , her MRS CF is 1. As we know that there is a diminishing MRS along an indifference curve, so we will have an MRS CF of 3 to the left of an MRS of 1 implying Marilyn needs to alter her consumption towards consuming more perfumes and less champagne to reach optimal consumption. Of course, what the final optimal bundle will be is not known to us unless we are given more information. All we know is that the budget constraint and an indifference curve has to be tangent to one another at the optimal bundle. I have denoted that optimal bundle with A .

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ECON 256: Intermediate Microeconomics Long Assignment: 3 2 2. (Textbook p. 78; Problem Question 10) For Alexi coffee and tea are perfect substitutes: One cup of coffee is equivalent to one cup of tea. Suppose Alexi has \$90/month to spend on these beverages and coffee costs \$0.90/cup while tea costs \$1.20/cup. Find Alexi’s best affordable bundle of tea and coffee. Explain your answer succinctly. Label the axes and graph clearly (use the graph space provided in the next page). Place cups of coffee/month on the horizontal axis and cups of tea/month on the vertical axis. Alexi's budget constraint (BC) is ° = 75 3 4 ± , with a slope of 3 4 . Her perfect substitute preferences yield linear indifference curves with slope equal to -1, such as T = 75 – C (IC 0 ) and T = 100 – C (IC 1 ). By consuming 90/0.90 = 100 cups of coffee each month, she reaches a higher indifference curve than consuming 90/1.20 = 75 cups of tea (or any affordable mixture of coffee and tea). [Indeed, as we know when MRS XY is greater than the price ratio of X and Y, we buy only X.] Thus at the optimal consumption bundle Alexi buys 100 cups of coffee and no tea (point A ).
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Long Assignment 3 Answer Key - ECON 256 Intermediate...

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