Question

1. The Barry family had two sons in college at the same time. Their parents gave both boys an allowance for food and textbooks. For simplicity, assume Drew and Brent have identical preferences between food and textbooks and that both are normal goods. Drew went to Georgia Tech University (GT), while Brent went to Oregon State University (OSU), where food prices were higher. Both boys bought their textbooks from an online store with free shipping and no tax, so they paid the same price for textbooks.

1. Using indifference curves and budget constraints, show the choices of Drew and Brent if the Barrys gave the boys the same allowance.
2. You might expect that Brent would be a little annoyed at the situation. Suppose he calls up his parents and convinces them that they need to give him more money to compensate him for the fact that food is so much more expensive in Oregon. His call is successful, and his parents agree to give him more money. Brent wants enough to buy the same bundle the Drew buys. Always wanting to treat their kids fairly, Brent’s parents instead give Brent enough money to be just as happy as Drew is (i.e., on the same indifference curve). Show this new budget constraint and Brent’s utility-maximizing choice of food and books.
3. Explain how your answer to the previous question help illustrate the income and substitution effects of a price change from Georgia’s low food prices to Oregon’s high food prices.

Answer 1