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# Budget Constraint

Wed 13 Jul, 2016 12:51 pm
Mia consumes two goods π₯1 and π₯2. Her preferences are represented by π’(π₯1, π₯2) =π₯1π₯2. The price of good π₯1 is denoted by π1, the price of good π₯2 is denoted by π2, and her income is denoted by π. Suppose Mia gets a weekly allowance of Β£100. Suppose both goods are Β£1 per unit.

Graph her budget constraint, and write down the equation of her budget line. In the same graph show Miaβs indifference curves corresponding to the utility levels π’ = 1000, π’ = 2500 and π’ = 4000. Solve for Miaβs optimal consumption bundle and indicate it in your graph.

Derive her demand functions for good 1 and good 2 as functions of her income, π, price of good 1, π1, and price of good 2, π2. Is good 1 normal or inferior? Ordinary or Giffen? Are goods 1 and 2 substitutes or complements?

Suppose the price of good 1 rises to Β£2. Calculate the equivalent variation in
income.
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