Question

John spends all his income of 10000 dollars on two commodities: cheese and wine. The price of cheese is 15 dollars (per kilogram) and the price of wine is 8 dollars (per liter).

a) Describe John's budget set.

b) In a two-dimensional coordinate system in which wine is measured in the vertical axis and cheese on the horizontal axis, draw the budget line of this consumer and show his budget set.

c) Find the points where the budget line hits the axes. At each of these points write down the quantities of each good consumed.

d) What is the slope of the budget line? And what is the economic interpretation of this slope?

e) Because of a new import tariff, the price of wine per liter increases to 20 dollars. On a separate graph, plot and show how the consumer's budget set is affected.

F) Because of a severe shortage in the supply due to a new quota on wine imports, a new rule is implemented by the only liquor store in town, allowing each consumer to purchase at most 5 liters of wine. Does this rule change the slope of the budget line? Show on a separate graph how the new rule affects the consumer's budget set.

Answer 1

Answer a)Budget line: M= Pc.C+ Pw.W

M= income, Pc= price of cheese, C= Quantity of cheese, Pw= price of wine , W= Quantity of wine

• Budget line: 10000= 15C+8W

• Budget set: 10000 less than or equal to 15C+8W

Answer b) Budget line is AB and shaded region OAB is budget set

Answer c) Budget line: 10000= 15C+ 8W

• X Intercept ( keeping W=0)= 666.67

• Y Intercept (keeping C=0) =1250

Answer d) Slope of budget line= Price of cheese/ Price of wine

​​​​​​Slope= 15/8

Interpretation: It is downward sloping which indicates that if one wants to consume more of one commodity then he has to reduce consumption of other commodities to stay within budget

Answer e) New budget line : 10000= 15C+ 20W

• X Intercept ( keeping W=0)= 666.67

• Y Intercept (keeping X=0)=500

The new budget line will rotate inwards from the Y axis.

In the diagram new budget line is A'B.

The shaded region OA'B is new budget set