1. Originally the consumer faces the budget line p1x1 + p2x2 = m. Then the price...

1. Originally the consumer faces the budget line p1x1 + p2x2 = m. Then the price of good 1 doubles, the price of good 2 becomes 8 times larger, and income becomes 4 times larger. Write down an equation for the new budget line in terms of the original prices and income.

2. What happens to the budget line if the price of good 2 increases, but the price of good 1 and income remain constant?

3. If the price of good 1 doubles and the price of good 2 triples, does the budget line become flatter or steeper?

Thank you!

Solutions

Expert Solution

1. New price of good 1 = 2p1
New price of good 2 = 8p2
New income = 4m
So, new budget line: 2p1 + 8p2 = 4m

2. Vertical intercept of budget line = Income/Price of good 2
Horizontal intercept of budget line = Income/Price of good 1
So, as income and price of good 1 remain constant then horizontal intercept does not change and as price of good 2 increases then ratio of income to price of good 2 decline which means vertical intercept decreases. Thus, budget line becomes flatter as vertical intercept decreases and horizontal intercept remains same.

3. New horizontal intercept = Income/2*(price of good 1)
New vertical intercept = Income/3*(price of good 2)
Both horizontal and vertical intercept will decline due to increase in prices of both goods.
So, decrease in vertical intercept > decrease in horizontal intercept because increase in price of good 2 is greater than increase in price of good 1. So, budget line becomes flatter.

Rahul Sunny answered 1 year ago

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