Consumer Choice

1.

Sarah divides her income only on 2 products; coffee and bread (both are normal goods).
An extreme cold winter in the US causes a large increase in the price of wheat and
(a) Draw the effect of the extreme cold winter on Sarah’s budget constraint.
(b) Draw the effect of the extreme cold winter on Sarah’s consumption preferences
assuming that the substitution effect outweighs the income effect for coffee.
(c) Draw the effect of the extreme cold winter on Sarah’s consumption preferences
assuming that the income effect outweighs the substitution effect for coffee.

2.

Assume Johan buys only milk and clothing. In year 1, Johan earns RM1 000, milk costs
RM10 per litre and clothing costs RM5 per yard.
(a) Draw Johan’s budget constraint.
(b) Draw Johan’s optimal combination of milk and clothing in year 1.
Assume in year 2, overall price increases by 10% and Johan’s salary increases by 12%.
(c) Draw Johan’s new budget constraint.
(d) Draw Johan’s optimal combination of milk and clothing in year 2.
(e) Compare between the optimal combination in year 1 and year 2.

3.

A college student has 2 options for meals: eating at Arked for RM5 per meal or eating at
cafeteria for RM4 per meal. The student weekly food budget is RM60. Assume that the
student spends equal amount on both options.
(a) Draw the budget constraint showing the trade-off between eating at Arked and
eating at the cafeteria for the college student.
(b) Draw the indifference curve showing the optimum choice. Label the point as A.
(c) Assume the price of meal at the cafeteria increases to RM4.50 per meal. Use the
diagram in part (a), show the effect of this price changes on the student’s optimal
combination. Assume the student now only use 30% of his income to eat at Arked.
Label the new optimum as B.
(d) Explain the effect of the price changes to the quantity demanded of meal at the
cafeteria using the substitution and income effects.

4. How many games does he play each week? 5. Daniel decides to get his difficult requirements out of the way. Daniel is a diligent student who loves getting As. With a new semester beginning. (a) Draw the new budget constraint for Daniel. Daniel is awake for 100 hours each week. Daniel must study for 20 hours per week for every A he earns. but also loves playing video games. Studying and playing games are his only 2 activities. . Each game is 2 hours long. (b) Using the diagram in (a). (a) Draw Daniel’s budget constraint that shows the trade-off between the number of As he can receive and the number of games he can play. draw an indifference curve that show his optimal combination of studying and games playing assuming that he is happiest when he earns 3 As. (c) Explain how will the relative strengths of the income and substitution effects determine whether Daniel makes better or worse grades and whether he plays more or fewer games. (b) Draw one possible optimal combination on the diagram in (a). Each class now requires him to study for 25 hours per week to get an A.