9

C h a p t e r
POSSIBILITES,
PREFERENCES,
AND CHOICES

Answers to the Review Quizzes

Page 244
1. What does a household’s budget line show?
The budget line plots combinations of goods that require all a household’s income and
describes the limits to its consumption choices.
2. How does the relative price and a household’s real income influence its budget line?
The magnitude of the slope of the budget line equals the relative price of the good or service
measured on the horizontal axis. A fall in the price of the good measured on the horizontal
(vertical) axis decreases that good’s relative price and decreases (increases) the slope of the
budget line. A household’s real income is the household’s income expressed as a quantity of
goods the household can afford to buy. An increase (decrease) in household income causes a
parallel shift of the budget line rightward (leftward). The slope of the budget line does not
change when income changes.
3. If a household has an income of $40 and buys only bus rides at $2 each and magazines at
$4 each, what is the equation of the household’s budget line?
The budget equation states that a household’s spending must equal its income. The budget
equation is derived for two goods, bus rides and magazines. The amount spent on bus rides is
(Pbus ride )×(Qbus ride ), the amount spent on magazines is (Pmagazine )×(Qmagazine ), and the
consumer’s income is y. We know that (Pmagazine )×(Qmagazine ) + (Pbus ride )×(Qbus ride ) = y.
Rearrange this equality by subtracting the amount spent on bus rides from both sides to give
(Pmagazine )×(Qmagazine ) = y – (Pbus ride )×(Qbus ride ). Finally, divide both sides by the price
of magazine to give the budget equation Qmagazine = y/P magazine – (Pbus
ride /Pmagazine )×(Qbus ride). Substituting in our values, y = $40, P bus ride = $2 and P magazine
= $4, gives Qmagazine = $40/$4 – ($2/$4)×(Qbus ride) which is equal to Qmagazine = 10 – 0.5
Qbus ride

4. If the price of one good changes, what happens to the relative price and the slope of the
household’s budget line?
A relative price is the price of one good divided by the price of another good. For example,
the magnitude of the slope of the budget line (Pmovie /Psoda) is the relative price of a movie in
terms of soda. This relative price shows how many sodas must be forgone to see an additional
movie. A fall in the price of the good on the horizontal (vertical) axis increases the total
affordable quantity of that good, decreases its relative price, and decreases (increases) the
magnitude of the slope of the budget line.

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5. If a household’s money income changes and prices do not change, what happens to the
household’s real income and budget line?
A household’s real income is the household’s income expressed as a quantity of goods the
household can afford to buy. For example, the vertical intercept for a budget line measuring
soda on the vertical axis is (y/Psoda), which is the consumer’s real income in terms of sodas.
A change in a household’s money income changes the household’s real income in terms of
both goods and causes a parallel shift of the budget line. If a household’s money income
increases, its budget line shifts rightward and if a household’s money income decreases, its
budget line shifts leftward.

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1. What is an indifference curve and how does a preference map show preferences?
An indifference curve shows those combinations of goods for which a consumer is indifferent.
The consumer has the same level of satisfaction for any combination on a given indifference
curve. The family of indifference curves is the preference map. This map shows the person’s
preferences because it shows how the person ranks each combination of goods. In particular,
the person prefers combinations on higher indifference curves to combinations on lower
indifference curves.
2. Why does an indifference curve slope downward and why is it bowed toward the origin?
The downward slope of an indifference curve illustrates the tradeoff between two goods while
maintaining the same level of total satisfaction. Since the consumer is indifferent among all
points on an indifference curve, when moving along it any increase in satisfaction from
gaining one good must be matched by an equal decrease in satisfaction from a loss in the other
good. An indifference curve is bowed toward the origin because the more of good x that is
consumed the less you are willing to give up of good y to get more of good x and remain
indifferent.
3. What do we call the magnitude of the slope of an indifference curve?
The magnitude of the slope of an indifference curve is called the marginal rate of substitution
(MRS). The MRS measures the rate at which the consumer gives up one good to get more of
another good, while remaining on the same indifference curve (keeping the consumer
indifferent about the changes). The bowed-in shape of the indifference curve is due to the
assumption of diminishing MRS.
4. What is the key assumption about a consumer’s marginal rate of substitution?
The key assumption about the marginal rate of substitution is that it is diminishing as a
consumer moves down an indifference curve, creating the bowed-in shape.

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1. When a consumer chooses the combination of goods and services to buy, what is she or he
trying to achieve?
The consumer is trying to achieve the highest level of well being possible.
2. Explain the conditions that are met when a consumer has found the best affordable
combination of goods to buy. (Use the terms budget line, marginal rate of substitution,
and relative price in your explanation.)
At the optimal consumption choice, the consumer’s consumption bundle is
1) on the budget line,
2) on the highest attainable indifference curve,
3) such that the slope of the budget line, which is the relative price of the two goods, equals
the slope of the indifference curve, which is the MRS.
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 WHAT IS ECONOMICS? 125
3. If the price of a normal good falls, what happens to the quantity demanded of that good?
If the price of a normal good falls, the quantity demanded of that good increases because the
substitution effect and the income effect both bring an increase in the quantity demanded.
4. Into what two effects can we divide the effect of a price change?
A price change can be divided into a substitution effect and an income effect. The substitution
effect is the effect of a change in price on the quantity bought when the consumer remains
indifferent between the original situation and the new situation. The income effect is the effect
of a change in income sufficient to get the consumer to the highest indifference curve that is
affordable on the new budget line reflecting the price change.
5. For a normal good, does the income effect reinforce the substitution effect or does it partly
offset the substitution effect?
For a normal good the substitution effect and the income effect reinforce each other, and a
decrease (increase) in the price of a good will always result in an increase (decrease) in the
quantity of the good demanded.

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Answers to the Study Plan Problems and Applications
Use the following information to work Problems 1 to 2.
Sara’s income is $12 a week. The price of popcorn is $3 a bag, and the price of a smoothie is $3.
1. Calculate Sara’s real income in terms of smoothies. Calculate her real income in terms of
popcorn. What is the relative price of smoothies in terms of popcorn? What is the opportunity
cost of a smoothie?
Sara’s real income is 4 smoothies. Sara’s real income in terms of smoothies is equal to her money
income divided by the price of a smoothie. Sara’s money income is $12, and the price of a
smoothie is $3. Sara’s real income is $12 divided by $3 a smoothie, which is 4 smoothies.
Sara’s real income is 4 bags of popcorn. Sara’s real income in terms of popcorn is equal to her
money income divided by the price of a bag of popcorn, which is $12 divided by $3 a bag or 4
bags of popcorn.
The relative price of a smoothie is 1 bag of popcorn per smoothie. The relative price of a smoothie
is the price of a smoothie divided by the price of a bag of popcorn. The price of a smoothie is $3
and the price of popcorn is $3 a bag, so the relative price of a smoothie is $3 divided by $3 a bag,
which equals 1 bag of popcorn per smoothie.
The opportunity cost of a smoothie is 1 bag of popcorn. The opportunity cost of a smoothie is the
quantity of popcorn that must be forgone to get a smoothie. The price of a smoothie is $3 and the
price of popcorn is $3 a bag, so to buy one smoothie Sara must forgo 1 bag of popcorn.
2. Calculate the equation for Sara’s budget line (with bags of popcorn on the left side). Draw a
graph of Sara’s budget line with the quantity of smoothies on the x-axis. What is the slope of
Sara’s budget line? What determines its value?
The equation that describes Sara’s budget line is
QP = 4 – QS. Call the price of popcorn PP and
the quantity of popcorn QP, the price of a
smoothie PS and the quantity of smoothies QS,
and income y. Sara’s budget equation is PPQP +
PSQS = y. If we substitute $3 for the price of
popcorn, $3 for the price of a smoothie, and $12
for the income, the budget equation becomes
$3QP + $3QS = $12. Dividing both sides by $3
and subtracting QS from both sides gives QP = 4
– QS.
To draw a graph of the budget line, plot the
quantity of smoothies on the x-axis and the
quantity of popcorn on the y-axis. The budget
line is a straight line from 4 bags of popcorn on
the y-axis to 4 smoothies on the x-axis.
The slope of the budget line, when smoothies are
plotted on the x-axis, is minus 1. The magnitude
of the slope is equal to the relative price of a smoothie. The slope of the budget line is “rise over
run.” If the quantity of smoothies decreases from 4 to 0, the quantity of popcorn increases from 0
to 4. The rise is 4 and the run is 4. Therefore the slope equals 4/4, which is 1.
Use the following data to work Problems 3 and 4.
Sara’s income falls from $12 to $9 a week, while the price of popcorn is unchanged at $3 a bag and
the price of a smoothie is unchanged at $3.
150 CHAPTER 9

3. What is the effect of the fall in Sara’s income on her real income in terms of (a) smoothies and
(b) popcorn?
a. Sara’s real income falls from 4 smoothies to 3 smoothies. Sara’s real income in terms of smoothies is
equal to her money income divided by the price of a smoothie. Sara’s money income is now $9 and
the price of a smoothie is $3. Sara’s real income is now $9 divided by $3 a smoothie, which is 3
smoothies.
b. Sara’s real income falls from 4 bags of popcorn to 3 bags of popcorn. Sara’s real income in terms of
popcorn is equal to her money income divided by the price of a bag of popcorn. Sara’s money
income is now $9 and the price of a bag of popcorn is $3. Sara’s real income is now $9 divided by $3 a
bag, which is 3 bags of popcorn.
4. What is the effect of the fall in Sara’s income on the relative price of a smoothie in terms of
popcorn? What is the slope of Sara’s new budget line if it is drawn with smoothies on the x-
axis?
The relative price of a smoothie is 1 bag of popcorn per smoothie, the same relative price as
before her income fell. The relative price does not depend on Sara’s income. Instead the relative
price of a smoothie is the price of a smoothie divided by the price of a bag of popcorn. The price
of a smoothie is $3 and the price of popcorn is $3 a bag, so the relative price of a smoothie is $3
divided by $3 a bag. The relative price equals 1 bag per smoothie.
The slope of the budget line, when smoothies are plotted on the x-axis is minus 1, the same slope
as before her fall in income. The magnitude of the slope of the budget line is equal to the relative
price of a smoothie. The relative price does not change when Sara’s income decreases so the slope
of the budget line does not change.
5. Sara’s income is $12 a week. The price of popcorn rises from $3 to $6 a bag, and the price of a
smoothie is unchanged at $3. Explain how Sara’s budget line changes with smoothies on the x-
axis.
The budget line rotates inward around the unchanged x intercept. The magnitude of the slope of
the budget line is equal to the relative price of a smoothie. The relative price of a smoothie is the
price of a smoothie divided by the price of a bag of popcorn. The rise in the price of a bag of
popcorn lowers the relative price of a smoothie in terms of popcorn. The relative price has fallen
so the magnitude of the slope of the budget line has fallen.
6. Draw figures that show your indifference curves for the following pairs of goods. For each pair,
are the goods perfect substitutes, perfect complements, substitutes, complements, or unrelated
goods?
 Right gloves and left gloves
Figure 9.2A is to the right. Right gloves/left gloves are
perfect complements. Because these are perfect
complements, the indifference curves are right angles.

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 POSSIBILITIES, PREFERENCES, AND CHOICES 151

 Coca-Cola and Pepsi

Figure 9.2B is to the right. These are, for most students,
almost perfect substitutes. The indifference curves should
either be linear (for perfect substitutes, as shown in Figure
9.2B) or nearly linear.

 Desktop computers and laptop computers

Figure 9.2C is to the right. These are substitutes, though not
perfect substitutes. The indifference curves are bowed inward
toward the origin.

 Strawberries and ice cream

Figure 9.2D is to the right. These are probably complements
for many students, though not perfect complements. The
indifference curves are not right angles, as they would be for
perfect complements, but instead are bowed inward toward
the origin.

7. Discuss the shape of the indifference curve for each of the following pairs of goods. Explain
the relationship between the shape of the indifference curve and the marginal rate of
substitution as the quantities of the two goods change.
 Sugar and honey
Sugar and honey are substitutes. They are not perfect substitutes, so the indifference curves are
bowed in toward the origin. The marginal rate of substitution falls moving down along an
indifference curve.

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 Movies and popcorn

These are complements but not perfect complements. The indifference curves should be
significantly bowed inward. The marginal rate of substitution falls rapidly moving down along an
indifference curve.
 Printers and printer cartridges
These are perfect complements so the indifference curves are right angles. The marginal rate of
substitution does not change moving down along the indifference curve. It changes only when
moving around the 90-degree point where it goes from infinity to zero.
 Snoods and scarves
These are nearly perfect if not perfect substitutes. The indifference curves should either be nearly
linear or linear. If the indifference curves are nearly linear, then the marginal rate of substitution
falls slightly moving down along an indifference curve; if the indifference curves are linear, then
the marginal rate of substitution does not change moving down along the indifference curve.
Use the following data to work Problems 8 and 9.
Pam has made her best affordable choice of cookies and granola bars. She spends all of her weekly
income on 30 cookies at $1 each and 5 granola bars at $2 each. Next week, she expects the price of a
cookie to fall to 50¢ and the price of a granola bar to rise to $5.
8. a. Will Pam be able to buy and want to buy 30 cookies and 5 granola bars next week?
Pam can still buy 30 cookies and 5 granola bars. When Pam buys 30 cookies at $1 each and 5
granola bars at $2 each, she spends $40 a week. Now that the price of a cookie is 50 cents and the
price of a granola bar is $5, 30 cookies and 5 granola bars will cost $40. So Pam can still buy 30
cookies and 5 granola bars. But Pam will not want to buy 30 cookies and 5 granola bars because
the marginal rate of substitution does not equal the relative price of the goods. Pam will move to a
point on the highest indifference curve possible where the marginal rate of substitution equals the
relative price.
b. Which situation does Pam prefer: cookies at $1 and granola bars at $2 or cookies at 50¢ and
granola bars at $5?
Pam prefers cookies at 50 cents each and granola bars at $5 each because she can get onto a higher
indifference curve than when cookies are $1 each and granola bars are $2 each. To see why Pam
can move to a higher indifference curve, note that the new budget line and the old budget line both
pass through the point 30 cookies and 5 granola bars. If granola bars are plotted on the x-axis, the
marginal rate of substitution at this point on Pam’s indifference curve is equal to the relative price
of a granola bar at the original prices, which is 2. The new relative price of a granola bar is $5/50
cents, which is 10. That is, the budget line is steeper than the indifference curve at 30 cookies and
5 granola bars. So Pam’s new equilibrium combination of cookies and granola bars must be on an
indifference curve at a point steeper than the initial indifference curve. Because the new budget
line is steeper and passes through the initial equilibrium combination, the new best affordable
point must lie above the initial equilibrium point so it must be on a higher indifference curve.
9. a. If Pam changes how she spends her weekly income, will she buy more or fewer cookies and
more or fewer granola bars?
Pam will buy more cookies and fewer granola bars. The new budget line and the old budget line
pass through the point at 30 cookies and 5 granola bars. If granola bars are plotted on the x-axis,
the marginal rate of substitution at this point on Pam’s indifference curve is equal to the relative
price of a granola bar at the original prices, which is 2. The new relative price of a granola bar is
$5/50 cents, which is 10. That is, the budget line is steeper than the indifference curve at 30
cookies and 5 granola bars. Pam will buy more cookies and fewer granola bars.

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b. When the prices change next week, will there be an income effect, a substitution effect, or
both at work?
There will be a substitution effect and an income effect. A substitution effect arises when the
relative price changes and the consumer moves along the same indifference curve to a new point
where the marginal rate of substitution equals the new relative price. An income effect arises when
the consumer moves from one indifference curve to another, keeping the relative price constant.
Use the following news clip to work Problems 10 and 11.
Hamptons Glamour Finds a Humbler Home
Romania’s Boom and Juice Sales Profructta is a juice manufacturing company in Romania. Over the
past few years, it has been feeling the effects of the unprecedented expansion that the Romanian
economy has been witnessing. Profructta’s revenue was close to €110,000 in 2016, which is twice its
revenue in 2015. Most of this increase is from sales of apple juice.
Sources: Fresh Plaza and The Guardian, 2017
10. a. According to the news clip, is apple juice a normal good or an inferior good? If the price of
apple juice rises and income remains the same, explain how the quantity of apple juice
bought changes.
According to the article, the demand for apple juice is increasing when the economy is in an
upturn and incomes are rising. Because the demand is increasing when income is increasing, apple
juice is a normal good.
If the price of apple juice rises and income remains the same, the quantity of apple juice purchased
decreases.
b. Describe the substitution effect and the income effect that occur.
The price rise creates both a substitution effect and an income effect. The substitution effect leads
to a decrease in the quantity of apple juice demanded. The price increase decreases consumers’
real incomes. Because apple juice is a normal good, the income effect leads to a decrease in the
quantity of apple juice purchased. Both effects
result in a decrease of the quantity demanded.
11. Use a graph of a family’s indifference curves
for apple juice and other goods. Then draw two
budget lines to show the effect of a rise in
income on the quantity of apple juice
purchased.
In Figure 9.3, the rise in income shifts the
budget line from BL1 to BL2. The quantity of
apple juice purchased increases, in the figure
from 5 units to 7 units.

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Answers to Additional Problems and Applications

Use the following data to work Problems 12 to 15.
Natalia has a budget of $24 a month to spend on fruit juice and books. The price of fruit juice is $3 a
bottle, and the price of a book is $6.
12. What is the relative price of a bottle of fruit juice in terms of a book and what is the
opportunity cost of a bottle of juice?
The relative price of fruit juice is 1/2 book. The relative price of fruit juice is the price of a bottle
of fruit juice divided by the price of a book. The price of fruit juice is $3 a bottle and the price of a
book is $6, so the relative price of fruit juice is $3 a bottle divided by $6 a book, which equals 1/2
book per bottle. The opportunity cost of a bottle of fruit juice is equal to half a book, which is the
quantity of books that must be foregone to obtain a bottle of juice.
13. Calculate Natalia’s real income in terms fruit juice? What is her real income in terms of
books?
Natalia’s real income is 8 bottles of fruit juice. Natalia’s real income in terms of bottles of fruit
juice is equal to her money income divided by the price of a bottle of fruit juice. Natalia’s money
income is $24, and the price of fruit juice is $3 a bottle. Natalia’s real income is $24 divided by $3
a bottle of fruit juice, which is 8 bottles of fruit juice.
Natalia’s real income is 4 books. Natalia’s real income in terms of books is equal to her money
income divided by the price of a book, which is $24 divided by $6 a book or 4 books.
14. Calculate the equation for Natalia’s budget line (with the quantity of fruit juice on the left
side).
The equation that describes Natalia’s budget line is QJ= 8 – 2QB. Call the price of a bottle of fruit
juice PJ and the quantity of fruit juice QJ, the price of a book PB and the quantity of books QB,
and income is y. Natalia’s budget equation is: PJQJ + PBQB = y. If we substitute $3 for the price
of a bottle of fruit juice and $6 for the price of a book, and $24 for income, the budget equation
becomes $3QJ + $6QB = $24. Next, divide both sides by $3 to obtain becomes QJ + 2QB = 8.
Finally, subtract 2QB from both sides to give QJ = 8 – 2QB.
15. Draw a graph of Natalia’s budget line with the quantity of books on the x-axis. What is the
slope of Natalia’s budget line? What determines its value?
The budget line equation is illustrated in Figure
9.4. The slope of the budget line, when books
are plotted on the x-axis is –2. The magnitude
of the slope is equal to the relative price of a
book. The slope of the budget line is “rise over
run.” If the quantity of books decreases from 4
to 0, the quantity of fruit juice increases from 0
to 8. The rise is 8 and the run is –4. So the
slope equals 8/–4, which is –2.

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Use the following data to work Problems 16 to 19.

Zeina has LBP 50,000 (Lebanese pound) a week to spend on juice and falafel sandwiches. The price
of juice is LBP 2,000 a glass, and the price of a falafel sandwich is LBP 5,000.
16. Calculate Zeina’s real income in terms of juice. Calculate the relative price of juice in terms of
falafel sandwiches.
Zeina’s real income in terms of juice is LBP 50,000/(LBP 2,000 per glass), which is 25 glasses per
week. The relative price of juice in terms of falafel sandwiches is (LBP 2,000 per glass)/(LBP
5,000 per sandwich) = 0.4 falafel sandwiches per glass of juice.
17. Calculate the equation for Zeina’s budget line (with falafel sandwiches on the left side).
The equation that describes Zeina’s budget line is QSANDWICH = 10 – 0.4QJUICE. Call the price of a
glass of juice PJUICE and the quantity of juice QJUICE, the price of a falafel sandwich PSANDWICH and
the quantity of falafel sandwiches QSANDWICH, and income y. Zeina’s budget equation is PJUICEQJUICE
+ PSANDWICHQSANDWICH = y. If we substitute LBP 2,000 for the price of a glass of juice, LBP 5,000 for
the price of a falafel sandwich and LBP 50,000 for income, the budget equation becomes LBP
2,000QJUICE + LBP 5,000QSANDWICH = LBP50,000. Next, divide both sides by LBP 5,000 to obtain
0.4QJUICE + QSANDWICH = 10. Finally subtract 0.4QJUICE from both sides to give QSANDWICH = 10 –
0.4QJUICE.
18. If Zeina’s income decreases to LBP 45,000 a week and the prices of juice and falafel
sandwiches remain unchanged, describe the change in her budget line.
Zeina’s budget line shifts inward and its slope does not change.
19. If the price of a falafel sandwich halves while the price of juice remains at LBP 2,000 a glass
and Zeina’s income remains at LBP 50,000 describe the change in her budget line.
Zeina’s budget line rotates outward. If the quantity of falafel sandwiches is plotted on the vertical
axis, the budget line rotates outward around the unchanged horizontal intercept (which is the
maximum number of glasses of juice Zeina can purchase) and becomes steeper.
Use the following news clip to work Problems 20 and 21.
Food Prices in Kenya Draining Consumers Food prices in Kenya are among the highest in the world.
An average urban family in Kenya spends almost half of its income on food, which heavily drains
expenditure that that could have otherwise been diverted towards education, clothing, and
investment.
Source: Daily Nation, February 26, 2011
20. a. Sketch a budget line for a Kenyan household that spends its income on only two goods: food
and education. Identify the affordable and unaffordable combinations of the two goods.

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Figure 9.5 shows a budget line. The

combinations of food and education that lie on
and inside the budget line are affordable. The
combinations of food and education that lie
beyond the budget line are unaffordable.

b. Sketch a second budget line to show how a

rise in the price of food changes the
affordable and unaffordable combinations of food and education. Describe how the
household’s consumption possibilities change.
The rise in the price of food rotates the budget vertically inward, as illustrated in Figure 9.6. The
combinations of food and education that were
previously affordable that have now become
unaffordable are shown by the grey triangle.
The household’s consumption possibilities
have been reduced.

21. How does an increase in the price of food

change the relative price of an hour of
education? How does an increase in the price
of food change real income in terms of food
and in terms of education? How does a
simultaneous fall in the price of education change the answers to these questions?
The relative price of education equals the price of an hour of education divided by the price of a
unit of food. The rise in the price of food reduces the relative price of education. It also decreases
real income in terms of food and does not change real income in terms of education. A
simultaneous rise in the price of food and fall in the price of education also decreases the relative
price of education. Real income in terms of food will decrease because of the increase in the price
of food, and real income in terms of education will increase because of the fall in the price of
education.

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Use the following information to work Problems 22 and 23.

Rashid buys only books and CDs and Figure 9.7 shows
his preference map.
22. a. If Rashid chooses 3 books and 2 CDs, what is
his marginal rate of substitution?
Rashid’s marginal rate of substitution is 1 book
per CD. Rashid’s marginal rate of substitution
equals the magnitude of the slope of his
indifference curve. If Rashid buys 3 books and 2
CDs, the slope of his indifference curve at this
point is minus 1 book per CD.
b. If Rashid chooses 2 books and 6 CDs, what is
his marginal rate of substitution?
Rashid’s marginal rate of substitution is 1/2.
Rashid’s marginal rate of substitution equals the
magnitude of the slope of his indifference curve.
If Rashid buys 2 books and 6 CDs, the slope of
his indifference curve at this point is minus 1/2
book per CD.
23. Do Rashid’s indifference curves display diminishing marginal rate of substitution? Explain
why or why not.
Rashid’s indifference curves display diminishing marginal rate of substitution. When moving
along either indifference curve the slope becomes smaller as the consumption of CDs increases,
which means that Rashid has diminishing marginal rate of substitution of books for CDs.
24. Happy Employees Want Raises and Respect at Work
A survey of 600 employees reports that employee satisfaction is at its highest level in 10
years, but satisfaction with benefits, compensation, time off, and “respectful treatment of
employees” at work, is low.
Source: The Calgary Herald, May 7, 2016
An earlier survey found that trust in management is a big component of job satisfaction. Say
you get a new boss and your trust in management goes up a bit (say, up 1 point on a 10-point
scale). That’s like getting a 36-percent pay raise. In other words, that increased level of trust
will boost your level of overall satisfaction in life by about the same amount as a 36-percent
raise would.
a. Measure trust in management on a 10-point scale, measure pay on the same 10-point scale,
and think of them as two goods. Sketch an indifference curve (with trust on the x-axis) that is
consistent with the news clip.
The clip implies that a 1 point increase in trust
combined with a 3.6 point (which is 36 percent
on a 10 point scale) decrease in income leaves the
person indifferent. So, as illustrated in Figure 9.8,
the indifference curve is linear showing the
tradeoff between trust and income.

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b. What is the marginal rate of substitution between trust in management and pay according to
this news clip?
The news clip implies that the indifference curves are linear (as illustrated in Figure 9.8) which
means that the marginal rate of substitution is constant and equal to 3.6 in the figure.
c. What does the news clip imply about the principle of diminishing marginal rate of
substitution? Is that implication likely to be correct?
The news clip implies that the indifference curves are linear, as illustrated in Figure 9.8. Linear
indifference curves mean that the marginal rate of substitution is constant, that is, the principle of
diminishing marginal rate of substitution does not hold. This assumption is likely to be incorrect.
Increasing trust in management from 0 to 1 is likely to be very worthwhile and the person will
give up a large amount of income to gain this unit increase. But increasing trust in management
from, say, 8 to 9 is probably not nearly so worthwhile because at 8 management is already highly
trusted. So to gain this unit increase in trust, the person is likely willing to give up only a small
amount of income. Hence, contrary to the article, increasing trust in management is subject to a
diminishing rate of substitution.
Use the following information to work Problems 25 and 26.
Najib has made his best affordable choice of sparkling water and jelly beans. He spends all of his
income on five bottles of sparkling water at $2 each and 10 jelly bean bags at $4 each. Now the price
of sparkling water rises to $2.50 a bottle and the price of jelly beans drops to $3.75 a bag.
25. Will Najib now be able and want to buy five bottles of sparking water and 10 jelly bean bags?
Najib is able to buy five bottles of sparkling water and 10 jelly bean bags because this
combination remains affordable. Najib will not want to buy this combination, however, because
the relative price of sparkling water and jelly beans has changed. At his consumer equilibrium,
Najib’s MRS equals the relative price of jelly beans and sparkling water and because the relative
price has changed, Najib’s MRS has changed so Najib will change his consumption point.
b. Which situation does Najib prefer: sparkling water at $2 a bottle and jelly beans at $4 a bag
or sparkling water at $2.50 a bottle and jelly beans at $3.75 a bag?
Najib prefers to buy sparkling water at $2.50 a bottle and jelly beans at $3.75 a bag because he can
attain a higher indifference curve. The new budget line goes through the old budget line at the
initial consumption point. But, with jelly beans measured along the horizontal axis, the new
budget line is flatter than the old budget line and lies beyond the initial budget line at all points
below the initial consumption point.
26. a. If Najib changes the quantities that he buys, will he buy more or less sparkling water and
more or less jelly beans? Explain your answer.
Najib will buy more jelly beans and less sparkling water. This is because the relative price of jelly
beans has dropped and the relative price of sparkling water has increased.
b. When the prices change, will there be an income effect, a substitution effect, or both at
work? Justify your answer.
Price changes can always be divided into an income effect and a substitution effect. As the price
of jelly beans falls and the relative price of jelly beans has dropped, Najib will substitute more
jelly beans for sparkling water. At the same time, when the price of jelly beans falls, real income
in terms of jelly beans increases and Najib can now afford to buy more jelly beans than he was
able to before.
Use the following data to work Problems 27 to 29.

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 POSSIBILITIES, PREFERENCES, AND CHOICES 159

Sara’s income is $12 a week. The price of popcorn is

$3 a bag, and the price of cola is $1.50 a can. Figure
9.9 shows Sara’s preference map for popcorn and
cola.
27. What quantities of popcorn and cola does Sara
buy? What is Sara’s marginal rate of
substitution at the point at which she
consumes?
Sara buys 6 cans of cola and 1 bag of popcorn.
Sara’s budget line runs from 8 cans of cola on
the x-axis to 4 bags of popcorn on the y-axis
and is tangent to indifference curve I1 at 6 cans
of cola and 1 bag of popcorn.
Sara’s marginal rate of substitution is ½. The
marginal rate of substitution is the magnitude
of the slope of the indifference curve at Sara’s
consumption point, which equals the
magnitude of the slope of the budget line. The
slope of Sara’s budget line is ½ bag of popcorn per can of cola so the marginal rate of
substitution is ½ bag of popcorn per can of cola.
28. Suppose that the price of cola rises from $1.50 to $3.00 a can while the price of popcorn and
Sara’s income remain the same. What quantities of cola and popcorn does Sara now buy?
What are two points on Sara’s demand curve for cola? Draw Sara’s demand curve.
Sara buys 2 cans of cola and 2 bags of popcorn.
Sara buys the quantities of cola and popcorn
that moves her onto the highest indifference
curve, given her income and the (new) price of
cola and price of popcorn. The budget line is
tangent to indifference curve I0 at 2 cans of
cola and 2 bags of popcorn.
Two points on Sara’s demand for cola are the
following: At $3 a can of cola, Sara buys 2
cans of cola. At $1.50 a can of cola, Sara buys
6 cans. Her demand curve is downward sloping
and, as Figure 9.10 shows, goes through these
two points.

29. Suppose that the price of cola rises to $3.00 a

can and the price of popcorn and Sara’s income
remain the same.
a. What is the substitution effect of this price change and what is the income effect of the price
change?
The substitution effect is 1 can of cola. To divide the price effect into a substitution effect and an
income effect, take enough income away from Sara and gradually move her new budget line back
toward the original indifference curve until it just touches Sara’s first indifference curve I1. The
point at which this budget line just touches indifference curve I1 is 5 cans of cola. The substitution

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160 CHAPTER 9

effect is the decrease in the quantity of cola from 6 cans to 5 cans along the indifference curve I1.
The substitution effect is 1 can of cola.
The income effect is 3 cans of cola. The income effect is the change in the quantity of cola from
the price effect minus the change from the substitution effect. The price effect is 4 cans of cola (2
cans minus the initial 6 cans). The substitution effect is a decrease in the quantity of cola from 6
cans to 5 cans. So the income effect is 3 cans of cola.
b. Is cola a normal good or an inferior good? Explain.
Cola is a normal good for Sara because the income effect is positive.

Economics in the News

30. After you have studied Economics in the News on pp. 254–255, answer the following
questions.
a. Dan is another student. In Fig. 2, draw Dan’s budget line in 2017 if he faced the 2017 level
of tuition but had a high enough income to be on indifference curve I1.
Figure 9.11 shows the budget line that enables
Dan to reach indifference curve I1 with the 2017
level of tuition. Dan will take 10 credits per
semester and consume $8,000 of other goods and
services—point B in the figure. The price of 10
hours of credits is $5,000. Dan’s total income is
$18,000.
b. What is Dan’s substitution effect of the tuition
rise?
Dan’s substitution effect from the tuition rise is to
reduce the number of credits he takes each
semester from 12 credits to 10 credits, so the
substitution effect is 2 credits. In the figure, the
substitution effect is the movement from point A
to point B.
c. What is Dan’s income effect of the tuition rise?
Presuming Dan has the same preferences as
Jessica, the income effect from the rise in tuition
is to is reduce the number of credits he takes each semester from (the hypothetical) 10 credits he
takes in part b to 8 credits, so the income effect is 2 credits. In the figure, the income effect is the
movement from point B to point C.
d. Identify Dan’s best affordable point.
Presuming Dan has the same preferences and income as Jessica, his best affordable point is point
C where he takes 8 credits per semester and consumes $6,000 worth of other goods and services.

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