Question
Matt considers Butter (B) and Sour Cream (S) as substitutes. His utility function has the form u(B, S) = B + S, where > 0.
Matt considers Butter (B) and Sour Cream (S) as substitutes. His utility function has the form u(B, S) = B + S, where > 0. Suppose the price of Butter is PB = 3, the price of Sour Cream is PS = 2, and Matt has an income of M = 100 dollars to spend between Butter and Sour Cream.
(a) In a well-labeled diagram, draw Matt's indifference map, putting Butter in the x-axis and Sour Cream in the y-axis. Make sure to indicate the direction in which the indifference curves increase.
(b) In a well-labeled diagram, draw Matt's budget set indicating the intercepts with the axes and the slope of the budget line.
(c) Obtain the Marginal Rate of Substitution between Butter and Sour Cream. What would happen to the MRS if Matt doubles his consumption of Butter and Sour Cream?
(d) Obtain Matt's optimal bundle when: - (i) > 3/2 (ii) < 3/2 (iii) = 3/2
(e) Now, suppose that the price of butter changes, whereas the price of the sour cream and Matt's income remain the same. The new price of Butter is P B = PB. What is the new Matt's optimal bundle? Does it depend on the value of ?
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