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Ms. Caffeine enjoys coffee (C) and tea (T) according to the function U(C, T) = 3C + 4T.

a. What does her utility function say about her MRS of coffee for tea? What do her indifference
curves look like?
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b. If coffee and tea cost $3 each and Ms. Caffeine has $12 to spend on these products,
howmuch coffee and tea should she buy to maximize her utility?

c. Draw the graph of her indifference curve map and her budget constraint, and show that the Intermediate.. Financial Principles of
. Accounting Accounting
utility-maximizing point occurs only on the T-axis where no coffee is bought. 11th Edition 10th Edition 10th Edition

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d. Would this person buy any coffee if she had more money to spend?

e. How would her consumption change if the price of coffee fell to $2?

Step-by-step solution

Step 1 of 5

a.

The consumer enjoys coffee (C) and tea (T) and her utility function is:

This above function is in linear form. This implies the Marginal Rate of Substitution (MRS) is
constant and the indifference curves are downward-sloping straight lines.

Comment

Step 2 of 5

b.

Calculate the marginal utility of coffee.

Calculate the marginal utility of tea.

Calculate the marginal utility of each dollar spent on coffee.

Calculate the marginal utility of each dollar spent on tea.

Since the marginal utility of each dollar spent on tea is always higher than the marginal utility of
each dollar spent on coffee, the consumer should spend her entire income of $12 on tea. That is,
the consumer should buy 0 units of coffee and 4 units (=12/3 units) of tea.

Comment

Step 3 of 5

c.

The required graph is shown in Figure 3.

The optimal bundle occurs on the x-axis where the entire income is spent on tea.

Comment

Step 4 of 5

d.

A rise in income will have no impact on the marginal utilities of the two goods, and therefore the
marginal utility of each dollar spent on tea will remain higher than the marginal utility of each
dollar spent on coffee. Therefore, at the given prices, the consumer would not buy any coffee
even if she had more money to spend.

Comment

Step 5 of 5

e.

Now the price of coffee is $2 and that of tea is still $3. Calculate the marginal utility of each dollar
spent on coffee.

Calculate the marginal utility of each dollar spent on tea.

Since the marginal utility of each dollar spent on coffee is now always higher than the marginal
utility of each dollar spent on tea, the consumer should spend her entire income of $12 on coffee.
That is, the consumer should buy 6 units (=12/2 units) of coffee and 0 of tea.

Comment

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