Answer to Question #158416 in Microeconomics for aqsa nabi

Question

Inayah is a rational consumer who consumes milk and cookies only from her monthly income of Rs. 1,500. If the price of milk is Rs. 500 per liter and the price of one pack of cookie is Rs. 300, answer the following questions:       

a)     Given the information above write the equation of the budget line and illustrate the same through the two-dimensional labeled diagram.                                                (1 Mark)

b)     If Inayah spends all of her income on consuming one good, find:                      (1 Mark)

                               i.           how much cookies she could afford?

                             ii.           how much milk she could consume?

c)     Identify the impact of an increase in the income from Rs. 1,500 to Rs. 1,800 on Inayah’s consumption level. Also illustrate it using the two-dimensional labeled diagram. (1 Mark) 

d)    Assume that Inayah’s consumption of milk and cookies give her following level of utility:

(2 Marks)

Quantity

MU _milk

MU _cookies

1

400

450

2

350

200

3

200

150

4

100

100

5

70

60

6

30

30

7

0

0

                               i.           Find the optimal level of consumption.

                             ii.           Find the consumer equilibrium using the two-dimensional labeled diagram.

Answer 1

a

Assume price of milk is p_x is and that of cookies is p_y .

â–ª If q_x units of milk is and q_y units of cookies is consumed

â–ª The income constraint, in the case of two commodities, may be written as

$I=pxqx+pyqy ...........(1)$

▪ This can be presented graphically by the budget line whose equation is derived from equation (1) by solving for qy

$qy=(I/py)-(pxqx)/py$

If $qx=0,$ then all the income I is spent on $I/py$ units of y.

If  $qy=0,$ then all the income I is spent on $I/px$ units of x 

These results are shown by points A and B in the figure represented below.

â–ª If we join these points with a line we obtain the budget line.

b (I)

$1500÷300=5$

(ik)

$1500÷500=3$

C

With increase in income, from Rs 1500 to Rs 1800 Inayah's purchasing po we increases he the budget line shifts to the right.