Question

Q.1 Assume a household’s budget is $10, the price of palm oil is $1 and the price of
cheese is $2:

i. Draw the household’s budget line on the diagram below. If they were to buy only one good or the other, how many total liters of oil could they buy? How many units of cheese?

ii. Indicate the point where the household will consume. How many liters of palm oil? How much of cheese? Label this Point as E.
iii. Assume the government was to tax palm oil consumption by $1, draw the new budget line on the graph.

iv. Redraw the households original budget line on the diagram, and draw a new budget line where the price of palm oil has doubled.
v. Is the household better off or worse off as a result of the tax? How do you explain?

Answer 1

The budget line for this household is $1p +2c=10$

If they were to buy only one good then

$1p=10$

$P=10$ for palm oil

$2c=10$

$c =5$ for cheese

The household is worse of with tax as it reduces the quantity of palm oil that they can afford

The new budget line is therefore

$2p+2c=10$

If they were to buy only palm oil then the no reduces from 10 to 5

$2p=10$

$p=5$