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Assume Carolyn is given a bundle on her budget constraint where her MRSFC = 2. Also...

Assume Carolyn is given a bundle on her budget constraint where her MRSFC = 2. Also assume the price of a unit of food equals $3 and the price of a unit of clothes equals $6. Should Carolyn buy more food or more clothes to maximize her utility? Why? Explain in detail.

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Answer #1

Here, slope of the indifference curve = MRSFC = 2. This means that Carolyn can give up 2 units of cloth for 1 unit of food.

Now, slope of budget constraint = Pc/PF = $6/$3 = 2.

As MRSFC=Slope of the budget constraint, Carolyn's utility is maximum. The indifference curve intersects the budget line at this point (equilibrium).

At this equilibrium point, she is indifferent between 2 units of food and 1 unit of cloth. Also, her preference matches with the market exchange rate.

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