#4-3-the-investment-opportunity-set #cfa #cfa-level-1 #economics #microeconomics #reading-14-demand-and-supply-analysis-consumer-demand #section-5-consumer-equilibrium #study-session-4
Currently, a consumer is buying both sorbet and gelato each week. His MRSGS [marginal rate of substitution of gelato (G) for sorbet (S)] equals 0.75. The price of gelato is €1 per scoop, and the price of sorbet is €1.25 per scoop.
- Determine whether the consumer is currently optimizing his budget over these two desserts. Justify your answer.
- Explain whether the consumer should buy more sorbet or more gelato, given that he is not currently optimizing his budget.
Solution to 1:
In this example, the condition for consumer equilibrium is MRSGS = PG/PS. Because PG/PS = 0.8 and MRSGS = 0.75, the consumer is clearly not allocating his budget in a way that maximizes his utility, subject to his budget constraint.
Solution to 2:
The MRSGS is the rate at which the consumer is willing to give up sorbet to gain a small additional amount of gelato, which is 0.75 scoops of sorbet to gain one scoop of gelato. The price ratio, PG/PS (0.8), is the rate at which he must give up sorbet to gain an additional small amount of gelato. In this case, the consumer would be better off spending a little less on gelato and a little more on sorbet.