Question

Assume that in a typical year, a teenager purchases 100 song-downloads and buys 80 cheese pizzas subject to a given annual allowance. With the theory of consumer behavior, if cheese pizza is an inferior good, graphically illustrate and carefully explain why a teenager would prefer a $50 cash gift over a $50 gift certificate at a local pizza store.

In this case, explain why the local pizza store’s manager would prefer in-store gift certificates over cash redeemable gift certificates?

Answer 1

If the consumer receives $50 cash gift then his entire income is increasing but if he gets a $50 gift certificate at a local pizza store then he can only increase his consumption of Pizzas. In this case, Pizza is an inferior good so he would not prefer to get a gift certificate for Pizza store than $50 cash gift. With the $50 cash gift, he can increase his purchase of song downloads which is his preference and normal good here.

In the fig, 1 AB is the budget line before gifts, AD is the budget line after pizza gift certificate and CD is the budget line if the consumer receives a cash redeemable gift certificate. We can see that N is the equilibrium quantity of songs and pizza consumer will purchase when there is a $50 gift certificate which less preferable then Point S where the consumer is increasing quantity of songs download purchase and decreasing the quantity of pizza.

A local pizza store’s manager will only prefer store gift certificates because it will increase its sale of pizza which is inferior good for the consumer. He knows consumer would not buy pizzas if he gives cash redeemable gifts and he will suffer only loss.