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. Include rough graphs.

Answer 1

Explanation:

The opportunity cost does not change because before Alphonso had to sacrifice 4 bus tickets when he ate a burger, because with the $2 that he spent, he could buy 4 tickets. And he had to sacrifice 1/4of a burger when he decided to purchase a bus ticket. Now he needs to sacrifice the same: if he decides to buy a bus ticket ($1) he sacrifices 1/4 burger and when he decides to buy a burger ($4), he sacrifices 4 bus tickets. His budget constraint is negatively affected because the price of both goods increased. If this income does not change, now he can consume less burgers and less bus tickets.

For example: Alphonson´s income was $8. Before, if he used all his income in burgers, he could purchase 4 units. And if he used all his income in bus tickets, he could purchase 16 units. Now (if his income remains the same), if he uses all his income in burgers, he can purchase 2 units. And if he uses all his income in bus tickets, he can purchase 8 units. The figure attached is the consumption possibilities frontier, which represents Alphonso´s consumption decisions. The slope represents the opportunity cost between burgers and bus tickets. Notice that the curve shifted to the left because now he can purchase less burgers and less bus tickets.