Question

John has $20 to spend on potato chips (X) and pretzels (Y). The price of a bag of potato chips is $4 and the price of a bag of pretzels is $2.5. How much is the market rate of substitution?

a. 0.625
b. 5
c. 8
d. 1.6

Answer 1

1.6

Step-by-step explanation:

The Market Rate of Substitution: The rate at which one good can be exchanged for another at current market prices. The Market Rate of Substitution for X with Y. The amount of Y which must be given up in order to get one more unit of X, given a fixed budget and market price .

DATA

Price of bag of potato chips = $4

Price of bag of pretzels = $2.5

Solution

Market rate of substitution = MUx / MUy = Px / Py

Market rate of substitution = 4 / 2.5

Market rate of substitution = 1.6