Home » The Indifference Curves below represent different combinations of gourmet pretzels and gourmet chips at two levels of utility.

The Indifference Curves below represent different combinations of gourmet pretzels and gourmet chips at two levels of utility.

The Indifference Curves below represent different combinations of gourmet pretzels and gourmet chips at two levels of utility. The consumer has $100 of income a month budgeted to the purchase of gourmet chips and pretzels. The price of gourmet chips is $14.29 for a 3-pack and the price of pretzels is $7.69 for a 3-pack.

Part 1: Use the infinite line tool to draw a budget constraint from the information given in the introduction to this problem and label it as the Budget Constraint 1 (Budget Const 1).

Part 2: Use the point tool to identify the utility maximizing combination of chips and pretzels and label it as Optimal Choice 1 (Opt Choice 1).

Part 3: Use the infinite line tool to draw a new budget constraint when the price of a 3-pack of chips falls to $10 from its previous price and label it Budget Constraint 2 (Budget Const 2).

Part 4: Use the point tool to identify the new utility maximizing combination of pretzels and chips that uses this individual’s entire budget, given the new price of chips, and label it as Optimal Choice 2 (Opt Choice 2).

Part 5: Now assume that enough income is taken away from the consumer with the original price of pretzels and the new price of chips that the consumer is returned to the original level of utility (Indifference Curve 1). Use the infinite line tool to draw this new budget line and label it as Budget Constraint 3 (Budget Const 3). (Hint: keep the positioning points far enough away from the axes that you can click and drag this budget constraint towards the origin as far as necessary.)

Part 6: Use the point tool to show the utility maximizing combination of pretzels and chips given Budget Constraint 3, and label it as Optimal Choice 3 (Opt Choice 3).

Part 7: Finally, use the vertical drop line tool to identify the initial level of chip consumption as “C starting” (C); then identify the level of chip consumption attributable to the new prices given the same level of utility and label it as the substitution effect, “C sub effect” (Cs); and lastly, identify the final component of the change in chip consumption as the income effect and label it as “C inc effect” (Ci).

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