Economic Problem

Topics: Consumer theory, Supply and demand, Price elasticity of demand Pages: 34 (9464 words) Published: December 1, 2012


1. An individual sets aside a certain amount of his income per month to spend on his two hobbies, collecting wine and collecting books. Given the information below, illustrate both the price-consumption curve associated with changes in the price of wine and the demand curve for wine.

|Price |Price |Quantity |Quantity |Budget | |Wine |Book |Wine |Book | | |$10 |$10 |7 |8 |$150 | |$12 |$10 |5 |9 |$150 | |$15 |$10 |4 |9 |$150 | |$20 |$10 |2 |11 |$150 |

The price-consumption curve connects each of the four optimal bundles given in the table, while the demand curve plots the optimal quantity of wine against the price of wine in each of the four cases. See the diagrams below.

2. An individual consumes two goods, clothing and food. Given the information below, illustrate both the income-consumption curve and the Engel curve for clothing and food.

|Price |Price |Quantity |Quantity |Income | |Clothing |Food |Clothing |Food | | |$10 |$2 |6 |20 |$100 | |$10 |$2 |8 |35 |$150 | |$10 |$2 |11 |45 |$200 | |$10 |$2 |15 |50 |$250 |

The income-consumption curve (see diagram at right) connects each of the four optimal bundles given in the table above. As the individual’s income increases, the budget line shifts out and the optimal bundles change. The Engel curve for each good illustrates the relationship between the quantity consumed and income (on the vertical axis). Both Engel curves (see diagrams below) are upward sloping, so both goods are normal.

3. Jane always gets twice as much utility from an extra ballet ticket as she does from an extra basketball ticket, regardless of how many tickets of either type she has. Draw Jane’s income-consumption curve and her Engel curve for ballet tickets.

Ballet tickets and basketball tickets are perfect substitutes for Jane. Therefore, she will consume either all ballet tickets or all basketball tickets, depending on the two prices. As long as ballet tickets are less than twice the price of basketball tickets, she will choose all ballet. If ballet tickets are more than twice the price of basketball tickets, she will choose all basketball. This can be determined by comparing the marginal utility per dollar for each type of ticket, where her marginal utility from another ballet ticket is 2 times her marginal utility from another basketball ticket regardless of the number of tickets she has. Her income-consumption curve will then lie along the axis of the good that she chooses. As income increases and the budget line shifts out, she will buy more of the chosen good and none of the other good. Her Engel curve for the good chosen is an upward-sloping straight line, with the number of tickets equal to her income divided by the price of the ticket. For the good not chosen, her Engel curve lies on the vertical (income) axis because she will never purchase any of those tickets regardless of how large her income becomes.

4. a. Orange juice and apple juice are known to be perfect substitutes. Draw the appropriate price-consumption curve (for a variable price of orange juice) and...
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