Question

In: Economics

1. The representative consumer (the consumer that his basket of goods is the same as the...

1. The representative consumer (the consumer that his basket of goods is the same as the "average" basket consumed by city dwellers) consumes two goods: Apple and oranges. The price of oranges is 1 dollar per unit and the price of apples is 2 dollars per unit. In year 1 the representative consumer consumed 10 units of oranges and 10 units of apples. The basket in year 1 is used to compute the CPI.

(a) In year 2 the price of oranges went up to 1.1 dollars per unit and the price of apples went up to 2.2 dollars per unit. What is the percentage change in the consumer price index (CPI)?

(b) Assume that income went up in year 2 and the income of the representative consumer is equal to the price of the basket that the consumer bought in year 1. What is the basket that is chosen by the representative consumer in year 2?

(c) Compare the welfare of the consumer in year 2 to his welfare in year 1.

2. Answer question 1 under the assumption that in year 2 the price of oranges went up to 1.2 dollars per unit but the price of apples did not change.

(a) What is the percentage change in the consumer price index (CPI)?

(b) Assume that the income of the representative consumer in year 2 is equal to the price of the basket that the consumer bought in year 1. Compare the basket chosen in year 2 to the basket chosen in year 1.

(c) Compare welfare in year 2 to welfare in year 1.

3. A consumer lives for two periods. His income in period 1 is !Y1 and his income in period 2 is Y . The consumer is free to lend and borrow at zero interest rate ( r =0

!

(a) What is the price of consumption in period 1 in terms of consumption in period 2? (How many units of period 2 consumption must the consumer give up to get an additional unit of consumption in period 1)?

(b) What is the maximum consumption that the consumer can have in the first period?

(c) Draw the budget constraint. In your graph have the endowment point, the slope and the intersections with the horizontal axis and with the vertical axis.

! 2 and!R=1+r=1).!Y1 =Y2 =10.

(d) The government introduces a tax of !T1 =5 in the first period. Use the graph in (c) to show the change in the budget line.

(e) How will the tax effect the consumer's consumption in the first period? How will it effect the consumer's consumption in the second period? (Assume that both goods are normal).

(f) Will the consumption in the first period change by more than 5 units? Why?

(g) Assume now that the government decides to impose the tax in the second period rather than the first. Will this change the budget line? Will this change the choice of consumption?

(h) Assume that initially government spending was zero in both periods. Then the government increased its spending in the first period to G =5 and financed it by

!
taxes of 5 units in the first period. What will happen to national savings? Explain.

4. Answer question 3 under the assumption that !r =0.1 (and !R =1.1 ). To simplify the calculations assume: Y =Y =11 . The questions are repeated here with slight

changes.

!1 2

(a) What is the price of consumption in period 1 in terms of consumption in period 2? (How many units of period 2 consumption must the consumer give up to get an additional unit of consumption in period 1)?

(b) What is the maximum consumption that the consumer can have in the first period?

(c) Draw the budget constraint. In your graph have the endowment point, the slope and the intersections with the horizontal axis and with the vertical axis.

(d) The government introduces a tax of !T1 =5 in the first period. Use the graph in (c) to show the change in the budget line.

(e) How will the tax effect the consumer's consumption in the first period? How will it effect the consumer's consumption in the second period? (Assume that both goods are normal).

(f) Will the consumption in the first period change by more than 5 units? Why?

(g) Assume now that the government decides to impose the tax in the second period rather than the first. Will this change the budget line? Will this change the choice of consumption? (Hint: the tax remains 5 units and not 5.5)

(h) Assume that initially government spending was zero in both periods. Then the government increased its spending in the first period to G =5 and financed it by

!
taxes of 5 units in the first period. What will happen to national savings? Explain.

Expert Solution

(b)

(c)

As we can see, in year 2 consumer's basket of good decreases which leads to the decline of the welfare loss of the consumer.

Rahul Sunny answered 2 years ago

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