Question

1. Alan states that he does not care whether he drinks Coke or Pepsi “as long as it is soda.” Assume that Alan can spend $100 per month on soft drinks.

1. Does Alan's statement violate any of the properties we require for preferences?
2. How many cans of Coke and Pepsi does Alan consume, respectively, if the price of Coke is $4 per can and the price of Pepsi is $2.50 per can?
3. How does your answer change, if the price of Pepsi increases to $3? What if it increases to $5?
4. Assume the original prices, but now assume that Alan's income doubles. Is he better off? How does his consumption of Coke and Pepsi change?
5. Illustrate your answers A) through C) graphically.

Answer 1

A.) Prefernces have various important properties that all together implies that consumer choices are consistent. Key properties are mentioned below:

• Preferences are complete
• Preferences are reflexive
• Preferences are transitive
• Preferences are monotonic.

In the given case, Pepsi and Coke are perfect supplements for Allan, and ther is no violation of any preference property due to that.

B) Since the products are perfect substitutes, Alan will consume the one with lower prices to maximise his utility. Allan will consume $100 / $2.50 = 40 cans of Pepsi in a month given a budget of $100. (Coke consumption = 0 can)

C) With the increase in Pepsi price to $3, it is still cheaper than Coke ($4).Since the products are perfect substitutes, Alan will consume the one with lower prices to maximise his utility. Allan will consume $100 / $3 = 33 cans of Pepsi in a month given a budget of $100. (Coke consumption = 0 can).

With increase in Pepsi price to $5, Coke becomes cheaper ($4), therefore Allan will spend the entire budget on Coke i.e., $100 / $4 = 25 Cans (Pepsi consumption = 0 can).

D) With the increase in income to $200 and the original prices, Allan would consume $200 / $2.50 = 80 cans of Pepsi (Coke consumption = 0 can) to maximise his marginal utility per dollar spent.(Preferences are monotonic).

E) The indiffernce curves are given below. Each curve slope = -1 (Marginal Rate of Substitution in case of perfect supplements)