Chapter 3: Consumer Behavior
27
Alcoholic
Nonalcoholic
J
1
J
2
S
1
S
2
Figure 3.6.a
b. Discuss why the two sets of curves are different from each other using the concept
of marginal rate of substitution.
At any combination of alcoholic, A, and nonalcoholic, N, drinks, Jones is willing to give
up a lot of N for an additional unit of A; whereas, Smith is willing to give up a lot of A
for an additional unit of N. Because Jones needs more N to compensate him for giving
up some A, he has a lower marginal rate of substitution of alcoholic for nonalcoholic
beverages than Smith. With alcoholic beverages on the vertical axis, Jones’ indifference
curves are less steep than Smith’s at any point on the graph.
c. If both Smith and Jones pay the same prices for their refreshments, will their
marginal rates of substitution of alcoholic for nonalcoholic drinks be the same or
different? Explain.
In order to maximize utility, the consumer must consume quantities such that the
MRS between any two commodities is equal to the ratio of prices. If Smith and Jones
are rational consumers, their MRS must be equal because they face the same market
prices. But because they have different preferences, they will consume different
amounts of the two goods, alcoholic and nonalcoholic. At those different levels, however,
their MRS are equal.
9. Antonio buys 8 new college textbooks during his first year at school at a cost of $50
each. Used books cost only $30 each. When the bookstore announces that there will be a 20
percent price increase in new texts and a 10 percent increase in used texts for the next
year, Antonio’s father offers him $80 extra. Is Antonio better off or worse off after the
price change?
It follows from the axiom of revealed preferences that, since Antonio chose to purchase
only new textbooks when both new and used textbooks were available, it must be the
case that Antonio does not consider used textbooks substitutes for new textbooks at the
old prices.
With the increase in price, however, to $60 for new textbooks and $33 for used texts, the
relative price of new texts to used texts increases from
50
30
167= . to
60
33
1 82= . . Antonio
may react to the relative price increase in one of two ways: