Tags
#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
Question
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.
- Explain whether the consumer should buy more sorbet or more gelato, given that he is not currently optimizing his budget.
Answer
The MRS
GS 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.