Question #51293

Stella is an 8 year old that gets a monthly allowance of $10 from her parents. There are only two things that Stella likes to spend her allowance on: chocolate bars and packages of stickers. Assume that initially chocolate bars cost $1 each and packages of stickers cost $2 each.
(a) Define the number of chocolate bars and packages of stickers Stella consumes as Qc and Qs respectively. Write down the equation that expresses the budget line facing Stella. Represent Stella’s budget line graphically with chocolate bars on the vertical axis and packages of stickers on the horizontal axis. Using an indifference curve, illustrate Stella’s choice if her utility maximizing consumption is 2 chocolate bars and 4 packages of stickers. [5-marks]
(b) Imagine that Stella has spent her allowance and made the optimal choice of consuming 2 chocolate bars and 4 packages of stickers. Suppose that we are given the information that Stella’s marginal utility from consuming more chocolate at this point is equal to 5. What is her mar

Expert's answer

Stella gets a monthly allowance of $10. Pch = $1, Pps = $2.

If as a result of the price change, the substitution effect caused Stella to increase her chocolate consumption by 4 chocolate bars, the income effect will be zero, because the change in consumption was only according to the substitution effect. We can't say whether Stella considers chocolate bars to be a normal or an inferior good, because we don't know the direction of the price change (increase or decrease). If the price decreased, then it is a normal good.

If as a result of the price change, the substitution effect caused Stella to increase her chocolate consumption by 4 chocolate bars, the income effect will be zero, because the change in consumption was only according to the substitution effect. We can't say whether Stella considers chocolate bars to be a normal or an inferior good, because we don't know the direction of the price change (increase or decrease). If the price decreased, then it is a normal good.

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