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Budget Constraint

 
 
Reply Wed 13 Jul, 2016 12:51 pm
Mia consumes two goods π‘₯1 and π‘₯2. Her preferences are represented by 𝑒(π‘₯1, π‘₯2) =π‘₯1π‘₯2. The price of good π‘₯1 is denoted by 𝑝1, the price of good π‘₯2 is denoted by 𝑝2, and her income is denoted by π‘š. 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 Mia’s indifference curves corresponding to the utility levels 𝑒 = 1000, 𝑒 = 2500 and 𝑒 = 4000. Solve for Mia’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‘š, price of good 1, 𝑝1, and price of good 2, 𝑝2. 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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