Econ 1
PS #4: Budget Constraints/Indifference Curves
Fall 2010
1.Every morning Professor Gordon buys a bagel and a cup of coffee from Peabody’s. At Peabody’s the price of bagels is $2.00 and the price of a cup of coffee is $1.00. a.Assuming that Professor Gordon has $20 to spend on coffee and bagels, sketch her budget constraint, putting coffee on the x-axis and bagels on the y-axis. Clearly label a) the x-intercept, b) the y-intercept, c) and the slope of the budget constraint. b.Now, suppose that Peabody’s wants to encourage customer loyalty. To do so they start the following program: every time someone purchases 10 cups of coffee, they get the 11thcup for free. Sketch Professor Gordon’s new budget constraint under the assumption that she still has $20 to spend on coffee. As above, put coffee on the x-axis and bagels on the y-axis. Clearly label a) the x-intercept, b) the y-intercept, c) and the slope of the budget constraint. In addition, if there are any changes in the slope of the budget constraint, clearly identify the coordinates (i.e. the points) where