In: Economics
John is indifferent between canned soup and fresh soup, that is, he derives as much pleasure (utility) from consuming x servings of canned soup as he does from consuming x servings of fresh soup. Canned soup sells for $1 per serving and fresh soup sells for $ 2 per serving. Assuming that John has $10 to spend on soup, how will he allocate his budget between the two types of soup? Explain your answer by drawing John's budget line and indifference curves.
Answer: For canned soup (C) and Fresh soups (F)
=> x Units of C can be substituted by x units of F
Price of canned soup Pc =$1 per serving
Price of Fresh soup PF =$2 per serving
Maximum budget for soups m= $10
The budget line formula here is:
10 = Pc * C + PF * F
=> 10 = 1 * C + 2 * F
=> 10 = C + 2 F
=> C = 5 - 0.5 F
He will spend all $10 on canned soup. As he gets the same utility with consuming same quantity of goods, .i.e canned soups are perfect substitute of fresh soups. Here exists a corner solution, He will get the maximum utilization by consuming the maximum units of soups.
He can have 10 servings of canned soup within the given budget of $10, while he can only purchase 5 units of fresh soup in $10.
hence he will maximize his utility by spending $10 all on canned soup.
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