Question

Which of the following statement are correct?

A.The set of affordable bundles will not change all prices and income income increase by thsane factor.

B.An increase in every price by 25% is equivalent to a 25%decrease of income at constant prices.

C.The set of affordable bundles decreases if the budget line becomes steeper.

D.An increase in every price by 20% is equivalent to a 25%decrease in income at constant prices.

E.An ncrease in every price by 25% is equivalent to a 20%decrease in income at constant prices.

Answer 1

Answer A) The statment is correct. This can be shown as suppose there are two goods x and y. Let Px and Py be the initial price and M be the initial income. The the budget constraint is

Px * X + Py *Y = M

Now suppose the prices and income both double then the same budget constraint becomes:

2Px*X + 2Py*Y =2M

Taking 2 as common we get the original budget set. So the statement is true.

B) The statement is true. This is because an increase in price will have the same effect as a decrease in income by the same amount given that the prices are constant.

C) The statement is true. The budget line becomes steeper when the price of the good rises. As a result with the rise in price the consumer is able to buy a lesser amount of the same good and the set of affordable bundle decreases.

D) and E) Both the statements are false. This is because since the prices are constant, an increase or decrease in the price must be associated with a decrease and increase in the income by the same amount respectively. A 20 percent increase in price must be associated with with a 20 percent decrease in income in income and not 25 percent.