Question

Show a consumer’s budget constraint and indifference curves for wine and cheese. Show the optimal consumption choice. If the price of wine is \(3 per glass and the price of cheese is \)6 per pound, what is the marginal rate of substitution at this optimum?

Short answer

The consumer’s budget constraint and indifference curves for wine and cheese are below:

The optimal consumption choice is given by point A.

The marginal rate of substitution between cheese and wine will be 2.

Step-by-step solution

Explanation

Consider the diagram below:

The budget line and the indifference curve are shown in the graph.

The tangency of the budget line and the indifference curve is where the optimum bundle of wine and cheese occurs.

Optimum consumption bundle

The optimum level will be at point A, and the W* and C* are the amount of wine and cheese consumed.

Marginal Rate of substitution

The marginal substitution rate is the rate at which the consumer is willing to substitute wine for more cheese. The marginal rate of substitution equates with the price ratio at the optimum level of consumption, i.e., .

Thus, the marginal rate of substitution is 2 (=6/3) at the optimum level.