Question

Scarcity as faced by an individual iii. Explain how individuals are constrained by their income and the prices they face? iv. Illustrate these concepts with the use of a budget line in a two good universe while mentioning dimension marginal utility.

Answer 1

Scarcity refers to the shortage or limited availability of resources.

Income acts as a budget constraint because consumers cannot consume beyond their income level that defines their limits. In a 2 good universe, that means if a consumer is consuming 2 commodities and is aware of the prices of both the commodities. Then the budget equation is P1X+ P2Y= M; Where P1 is the price of good X and X represents the quantity of good X, P2 is the price of good Y and Y represents the quantity of good 2, M shows the income level of the consumers.

Let's assume if income is $20 = M, P1 is $4 and p2 is $2, then the budget equation becomes:

4X +2Y = 20, In order to increase the consumption of Y commodity the consumer, must sacrifice the consumption of X commodity. Let's see the different combinations of the goods that a consumer can buy with this income.

If a consumer spends his entire income on good Y, then the consumption of good X will be 0;

4 X 0 + 2 X Y = 20; then Y will be 10, similarly If X = 1 then Y will be 8, if X = 2, then Y = 6, if X = 3, then Y = 4, if X = 4 then Y = 2 and if X = 5 then Y = 0.

Given the income, we got different combinations for the budget line. As you plot these combinations, you will get a negatively sloped budget line like this :

The slope of the budget line = -p1/p2, so to increase the consumption for Good X, consumer has to sacrifice the consumption for good Y because income is limited. Marginal Utility works on the same concept it shows, change in total satisfaction divided by the units consumes, so this negatively sloped Budget line also represents the MU line.