1. Consider a consumer with 100 units of income that can be expended in books (...

1. Consider a consumer with 100 units of income that can be expended in books ( good 1) and other goods ( good 2). The prices of these goods are: p(1) = 1, and p(2) = 2.

(i) Write down - and make a picture- of the budget constrain of the consumer, and its budget set.
¿What is the economic interpretation of the slope of the budget constrain?.
(ii) Do the same as before when the income of the consumer increases up to 150 monetary units.
(iii) Supose that income is still 100 units, but the price of the good one is p ́(1) = 2. Do the same as in the case (i).

Consider the initial situation of the consumer. Supose that the goverment wants to stimulate people to read more. And to do that, the goverment consider the following policies.

(a) Subsidize with 25 monetary units to the consumer.

(b) Subsidize with 0.20 monetary units per book

Solutions

Expert Solution

(i) Budget Constraint is given as : Y = P1.X1 + P2.X2

where Y is the income, P1 is the price of commodity 1, P2 is the price of commodity 2, X1 is the quantity of commodity 1, X2 is the quantity of commodity 2.

In this case, Budget Constraint will be: 100 = X1 + 2X2

where, P1 (price of books) = 1

P2 (other goods) = 2

Budget set includes all the possible consumptions a person can afford given the prices and income of that person. The budget set is presented by the area under the budget constraint.

Slope of budget constraint = - P2/P1 = -2

Slope of budget constraint lets us analyse the goods that have to be given up inorder to consume more of the other good.

As in the graph we presented X2 on x axis and X1 on y axis.

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(ii)

Now, income increases to 150.

Budget Constraint = 150 = X1 + 2X2

The budget constraint will shift towards right with an increase in income. Budget set will increase and the affordability of the goods will increase for the consumer.

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(iii)

Now with income 100, and P1 = 2 and P2 = 2, Consumer will be able to buy the maximum of 50 units of both the goods. The consumption of X1 will fall from 100 to 50.

Slope of budget constraint = -1

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Rahul Sunny answered 1 year ago

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