I consume two goods, Ice Cream and Biscuits. I shop once a week, spending $100,

Question

I consume two goods, Ice Cream and Biscuits. I shop once a week, spending $100, at either Wal-mart or Target. Interestingly, I've noticed that the bundle I purchase when I visit Target costs more at Wal-mart. Similarly, the bundle I purchase when I visit Wal-mart costs more at Target. And yet, I find that I get the same utility from shopping at either store (i.e. the Wal-mart shopping bundle gives me the same utility as the Target shopping bundle). Explain how it is possible for all of these statements to be true. (Hint: draw a single indifference curve and have me maximize utility given a $100 budget and different prices in the two stores).

Explanation / Answer

The reason this works is that neither bundle is maximizing utility. Draw an arbitrary indifference curve, U1. Now draw an arbitrary income line, I1, that intersects the indifference curve in two places. Each point of intersection represents a different bundle that has the same cost and utility but different prices. For extra suck-up points, draw a second indifference curve, U2 , that is tangent to I1. The tangent point represents the prices KMart would charge to maximize your utility.

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