Question

Suppose Alphonso’s town raises the price of bus tickets from \(0.50 to \)1 and the price of burgers rises from \(2 to \)4. Why is the opportunity cost of bus tickets unchanged? Suppose Alphonso’s weekly spending money increases from \(10 to \)20. How is his budget constraint affected from all three changes? Explain.

Short answer

The opportunity cost of bus tickets remains unchanged at 0.25 because both the price of bus tickets and the price of burgers have doubled. Alphonso's budget constraint is affected by his increased weekly spending money, which has also doubled from \(10 to \)20, allowing him to buy the same combination of bus tickets and burgers if he spends his entire budget.

Step-by-step solution

Calculate the initial opportunity cost of bus tickets

Initially, the price of a bus ticket is \(0.50 and the price of a burger is \)2. We can calculate the opportunity cost of bus tickets (how many burgers he can buy instead of one bus ticket) by dividing the price of a bus ticket by the price of a burger. Initial opportunity cost of bus tickets = \( \frac{0.50}{2} \) = 0.25

Calculate the new opportunity cost of bus tickets after the price changes

After the price changes, a bus ticket costs \(1 and a burger costs \)4. Calculate the opportunity cost of bus tickets again using the new prices. New opportunity cost of bus tickets = \( \frac{1}{4} \) = 0.25

Compare the initial and new opportunity costs of bus tickets

The initial opportunity cost of bus tickets is 0.25, and the new opportunity cost of bus tickets is also 0.25. Thus, the opportunity cost of bus tickets remains unchanged.

Analyze the change in Alphonso's weekly spending money

Initially, Alphonso has \(10 per week to spend on bus tickets and burgers. After the change, his weekly spending money increases to \)20. This means his budget constraint has expanded and he can buy more of either or both of the items he spends money on.

Explain the effect of all three changes on Alphonso's budget constraint

The price of bus tickets has doubled from \(0.50 to \)1, and the price of burgers has also doubled from \(2 to \)4. Meanwhile, Alphonso's weekly spending money has also doubled from \(10 to \)20. As the opportunity cost of bus tickets remains the same, the only change in Alphonso's budget constraint would be the increase in his weekly spending limit. Since his income has doubled, Alphonso can still buy the same combination of bus tickets and burgers as before if he chooses to spend his entire budget.

Key concepts

Budget Constraint

The budget constraint is a fundamental concept in microeconomics that represents the combinations of goods and services a consumer can purchase with their limited resources. Imagine you have a finite amount of money to spend; the budget constraint outlines the trade-off between different goods given their prices and your available funds.

For instance, let's take the exercise about Alphonso. Initially, with \(10, maybe he could buy 20 bus tickets or 5 burgers. The budget line would show all combinations of bus tickets and burgers he could purchase. However, when his weekly allowance increases to \)20, while the prices of both goods double, this shifts his budget line outward. This means that although the prices have increased, Alphonso's purchasing power remains relatively the same because his income has risen proportionately. Nevertheless, his budget constraint now allows for increased combinations of purchases. He could decide to buy more bus tickets or more burgers, or he could stick to the same bundle he bought before the price and income changes.

Price Elasticity

Price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price. It is a critical indicator of the sensitivity of consumers to price changes. Elastic demand means that a small price change causes a large change in the quantity demanded, whereas inelastic demand implies that quantity demanded is less responsive to price changes.

Let's relate this to the example provided. If the demand for bus tickets and burgers were very elastic, the doubling of their prices would result in a large decrease in the quantity of both that Alphonso would buy. However, since his income also doubled, it compensates for the increased prices, potentially leaving the quantity demanded unchanged. The calculation of elasticity involves the percentage change in quantity demanded divided by the percentage change in price. In terms of opportunity cost, if the price elasticity of burgers is relatively high compared to bus tickets, Alphonso might forego burgers in favor of more bus tickets after the price change.

Microeconomics

Microeconomics is the study of how individuals and firms make decisions and how they interact in specific markets. It's all about supply and demand, and how various factors affect them. Central to microeconomics is understanding how scarcity and limited resources compel choices regarding what to consume. These choices, in turn, reflect opportunity costs, which are the next best alternatives forgone when a decision is made.

Regarding our example with Alphonso, microeconomic principles tell us that his decision-making will depend on how he values bus rides compared to burgers after the price increase and his budget enhancement. His decision on what to purchase and in what quantities will ultimately reflect the utility or satisfaction he expects to derive from his choices, given his budget constraint and the unchanged opportunity cost. Microeconomics helps explain the behaviors of consumers like Alphonso and is instrumental in predicting how changes in prices, income, and other factors impact consumer choices.