Question

1. Assume that Joe is a college student who has $25 a week to allocate for soda pop or potato chips.  If soda pop costs $2.50 a pack and chips cost $2.00 a bag, draw the specific budget constraint for Joe.  Show what would happen to Joe’s budget constraint if the price of chips increased to $2.50 a bag.  On a new graph, start with the original budget constraint and show what would happen instead if Joe’s income fell to $20.

Answer 1

Suppose Joe conusmes soda pop = c

And potato chips = y

Joe's budget constraint is,

2.5x + 2y = 25

The maximum amount of soda pop he can consume if if spends all his money on soda pop = 25/2.5 = 10 units

The maximum amount of chips he can consume umif he spends all his money on chips = 25/2 = 12.5 units

His budget line is represented by BL.

b) If peice of chips increases to $2.5, then new budget constraint,

2.5x + 2.5y = 25

The maximum amount of soda pop he consumes if he spends all his money on soda pops remains the same but maximum amount of chips he can consume falls to 10 units. Thus, budget line, BL, pivots inwards about B.

c) If his income falls to $20, then

The new budget constraint,

2.5x + 2y = 20

This means the maximum consumption of both chips and soda pop will fall to 10 units and 8 units respectively. Thus, the budget line shifts inwards to AC.

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