Question

2. Suppose utility for a consumer of cereal (x) and milk (z) is U = min(x, 2z), where 2 boxes of cereal are consumed with one carton of milk (x=2z).

a. What is the optimal consumption bundle if $42 are allocated to cereal and milk over a 6-month period, and the price of cereal is $3 and price of milk is $2?

b. Graph the situation, including indifference curves, budget line, and the optimal choice.

Answer 1

a. This is a case of an indifference where substitution of one product for another doesn't help. The consumer has a fixed bundle (or proportion) of the two goods, which in this case is 2 boxes of cereal and 1 carton of milk. This bundle costs $7, i.e., $3*2 + $2 = $8. He will consume $42/$8 = 5.25 such bundles over the 6 month period using his budget of $42

b. Pls see graph below. Milk on vertical axis and cereal on horizontal axis. Blue one is the budget line, orange ones indifference curves. The higher orange one is the IC that meets budget line at 10.5, 5.25