Question

A consumer wants to consume two goods. The prices of the two goods are Rs 4 and Rs 5 respectively. The consumer’s income is Rs 20. (i) Write down the equation of the budget line. (ii) How much of good 1 can the consumer consume if she spends her entire income on that good? (iii) How much of good 2 can she consume if she spends her entire income on that good? (iv) What is the slope of the budget line? 

Answer 1

Let us assume that the consumer wants to buy X amounts of Good 1 and Y amount of Good 2. As given, Good 1 is priced at Rs.4 and Good 2 is priced at Rs.5. The income of the consumer is Rs.20.

i) The budget line can be represented using the equation 4X + 5Y = 20

ii) If the consumer spends the entire income on good 1, the value of Y will be zero.

Hence, 4X + 5(0) = 20

X = 20/4 = 5

Therefore, 5 units of Good 1 can be bought.

iii) If the consumer spends the entire income on good 2, the value of X will be zero.

Hence, 4(0) = 5Y = 20

Y = 20/5 = 4

Therefore, 4 units of Good 2 can be bought.

iv) The slope of the budget line can be determined by the units of good 1 that the consumer is willing to give up for gaining equivalent amounts of good 2.

P1/P2 = -4/5 = 0.8

1. equation 4X + 5Y = 20
2. X = 5
3. Y = 4
4. P1/P2 = 0.8