Question

John Q. Public spends all of his income on CDs and hamburgers. Draw his budget constraint for these products when the following are true: 1) Graph A: his income is $80, the cost of a CD is $2 and a cost of a burger is $2. 2) Graph B: his income is $120, the cost of a CD is $2 and the cost of a burger is $2. 3) Graph C: his income is $80, the cost of a CD is $5 and the cost of a burger is $2. 4) Add an indifference curve into graph A. How many CDs and burgers will he buy to be at equilibrium? 5) Add an indifference curve into graph B. How many CDs and burgers will he buy to be at equilibrium? 6) Add an indifference curve into graph C. How many CDs and burgers will he buy to be at equilibrium? 7) Does the equilibrium level of CDs and burgers change due to the changes in income and costs?

Answer 1

Let the indifference curve of U = XY. Here in Graph A the budget line has an equation 80 = 2CDs + 2Hams. The current optimal choice is at A where CDs = 20, Hamburger = 20 and utility is U = 20*20 = 400 utils

Here in Graph B the budget line has an equation 120 = 2CDs + 2Hams. The current optimal choice is at B where CDs = 30, Hamburger = 30 and utility is U = 30*30 = 900 utils

Here in Graph C the budget line has an equation 80 = 5CDs + 2Hams. The current optimal choice is at C where CDs = 8, Hamburger = 20 and utility is U = 8*20 = 160 utils

In all the three diagrams we see that the equilibrium level of CDs and burgers change due to the changes in income and costs. This is shown by different consumption bundles at new equilibrium.