Answer to Question #41664 in Economics of Enterprise for Mushfik Ahmed

Question

1. A consumer splits their income equally between two goods. If the price of one good increases by 10% and their income increases by 5%, show that the consumer’s optimal consumption bundle will change despite them being able to afford their original bundle.

2. When estimating a demand function, explain why fitting a line of best fit through observed price and quantity combinations over time is not likely to yield good estimates.

3. If a firm uses only capital and labour, show why the cost minimising combination of inputs sets: .

Answer 1

1. If the price of one good increases by 10% and the income increases by 5%, the consumer will increase consumption of the second good and decrease the consumption of the first one, because the second good became comparatively cheaper than before.
2. A line of best fit (or "trend" line) is a straight line that best represents the data on a scatter plot.
This line may pass through some of the points, none of the points, or all of the points. As it is a straight line it gives only average estimates, so this method is not very correct.
3. The least-cost combination of inputs occurs at the point where the marginal rate of substitution between the inputs equals the ratio of their prices.