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Budget and Marginal Rate of Substitution

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.