Question

Mike derives utility from the consumption of cheeseburgers (C) and Pepsi
(P). If Pc=$1.50/burger, Pp=$1/glass, and income=$25/day, Mike chooses to
consume 10 cheeseburgers and 10 Pepsi's per day. If Pc falls below $1.50, Mike will
still consume 10 cheeseburgers/day. (explain your reasoning in detail to get full
credit)
A. Does Mike consider cheeseburgers to be a normal or an inferior good?
B. Is Pepsi a normal or inferior good? Can you tell?

Answer 1

Normal goods: The decrease in price increases the purchasing power of consumer, which leads to the increasing consumption of the product.

Inferior goods: The decrease in price although increases the purchasing power of consumers, but they don’t want to consume more of the good because the good is inferior.

Here the initial budget equation is as below:

Income (I) = Quantity of C (Qc) × Price of C (Pc) + Quantity of P (Qp) × Price of P (Pp)

I = QcPc + QpPp

This is fulfilled by the initial purchasing as below:

25 = 10 × 1.5 + 10 × 1 = 15 + 10 = 25 (satisfied)

Now, the price of C drops (say to $1); the budget equation would be as below:

I = QcPc + QpPp

25 = 10 × 1 + 15 × 1 = 10 + 15 = 25 (satisfied)

There is no increase in consumption of C, but he increases the consumption of P to satisfy the above equation; it indicates that C is an inferior good and P is a normal good.

A. Product C is inferior, since the reduction of its price doesn’t increase its quantity consumption.

B. Product P is normal, since increase in income (by the effect of reduction in price) increases its quantity consumption.