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# Budget and Marginal Rate of Substitution

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Upscale hotels in the United States recently cut their prices by 25% in an effort to bolster dwindling occupancy rates among business travelers. A survey performed by a major research organization indicated that businesses are wary of current economic conditions and are now resorting to electronic media, such as the Internet and the telephone, to transact business. Assume a company's budget permits it to spend \$6,000 per month on either business travel or electronic media to transact business. Graphically illustrate how a 25% decline in the price of business travel was initially \$1,200 per trip and the price of electronic media was \$600 per hour. Suppose that, after the price of business travel drops. The company issues a report indicating that its marginal rate of substitution between electronic media and business travel is -1. Is the company allocating resources efficiently? Explain.

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#### Solution Preview

Define the following variables:

= price of business travel
= price of electronic media per hour.
= total budget per month.

Write an inequality relating the price of business travel and the price of electronic media ...

#### Solution Summary

A step-by-step solution with equations and two graphs is provided in a .png.

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## Consumer Budget Constarint

Question 1. Page 154 (with some modifications)

A consumer has \$300 to spend on goods X and Y. The market prices of these two goods are Px = \$15 and Py = \$5.

a. Draw the budget constraint. I.e. provide a carefully labeled diagram
b. What is the market rate of substitution? Give an interpretation.
c. Illustrate the consumer's opportunity set in part a) above.
d. Show how the consumer's opportunity set changes if income increases by \$300.
e. Does the increase of income by \$300 in part d) above alter the market rate of substitution between goods X and Y?

Question 3 (with some modifications to the question). On page 155
A consumer must spend \$600 between the consumption of product X and Y. The relevant market prices are Px = \$10 and Py = 40.

a. Write the equation for the consumer's budget line
b. Illustrate the consumer's opportunity set in a carefully labeled diagram.
c. Show how the consumer's opportunity set changes when the price of good X increases to\$20.
d. Does the change in the price of good X in part c alter the market rate of substitution between goods X and Y?

Instructions: For each part of the above question, show your work. Graphs may be useful. Explain and show all steps of how you have reached your answer. Don't simply state your answer.

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