A college student has two options for meals: eating at the dining hall for $6 pe

Question

A college student has two options for meals: eating at the dining hall for $6 per
meal, or eating a Cup O’ Soup for $1.50 per meal. His weekly food budget is
$60.
a. Draw the budget constraint showing the trade-off between dining hall meals
and Cups O’ Soup. Assuming that he spends equal amounts on both goods,
draw an indifference curve showing the optimum choice. Label the optimum as
point A.
b. Suppose the price of a Cup O’ Soup now rises to $2. Using your diagram
from part (a), show the consequences of this change in price. Assume that our
student now spends only 30 percent of his income on dining hall meals. Label
the new optimum as point B.
c. What happened to the quantity of Cups O’ Soup consumed as a result of this
price change? What does this result say about the income and substitution
effects? Explain.
Exercise 2: (continued )
The rent control agency of Hanoi has found the aggregate demand and
aggregate supply for house renting market was
Qd = 100 – 5P
Qs = 50 + 5P
While Q: is measured by thousands of apartments
P: is

Explanation / Answer

Given $6 per meal, or eating a Cup O’ Soup for $1.50 per meal. His weekly food budget is $60. CS actually increased by one as a result of the price increase. This implies that CS is a Giffen good (A special type of inferior good) and that the income effect is greater than the substitution effect. The substitution effect makes me buy less soup but the income effect makes me buy more soup because soup is an inferior good. So, if I end up buying more soup, it must be that the income effect is stronger than the substitution effect.

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