Question

Assume that you have a budget of $30 to spend on milk and cereal only. The price of milk is PM = $4.00 and the price of cereal is PC = $5.00. Answer the following quesitons.

2(a) Graph the budget constraint. Be sure to put the quantity of milk (QM) on the horizontal axis.

2(b) What is the most you can purchase of cereal?

2(c) If you purchase 4 units of cereal (QC = 4), then how many units of milk can you purchase at most?

2(d) What is the slope of the budget constraint? (Note: it is important that you answer Question 2(a) correctly and put QM on the horizontal axis.) 2(e) What is the opportunity cost of three units of cereal?

Answer 1

We can set the budget equation, M = mPm + cPc.

30 = 4m+5c

When, m =0, 30=5c or, c =6

When, c=0, 30 = 4m or, m =7.5

Putting these two points on the graph with quantity of milk on the horizontal axis and joining the two points, we get the bugdet line.

---

Since, 30 = 4m+5c

Maximum cereal that we can purchase will be when all ofotheof income is used to purchase cereal.

So, 30 = 4(0)+5(c) or, 30=5c or, c=6 units

---

If c=4,

30= 4m + 4(5) or, 4m=30-20

Or, m = 10/4 = 2.5 units.

---

Slope of budget line = -Pm/Pc = - 4/5

Okay so, 30 = 4m+5c.

5c = 30 - 4m or, c = (30-4m)/5

Or c = - m(4/5) + 6

This is in the slope intercept form, y=mx+c

Where c is the intercept and m is the slope.

Here, slope = -4/5

---

Opportunity cost is the best alternative forgone.

If he consumes 3 units of cereal, it is costing him 3×5 = 15

He can instead uses this money to buy milk,

He could have bought 15 = 4m or, m = 3.75 units.

Thus, opportunity cost of 3 units of cereal = 3.75 units of milk.

---