Answer to Question #159371 in Microeconomics for Roy

Question

Question 02                                        05 Marks   

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:   

1. Given the information above write the equation of the budget line and illustrate the same through the two-dimensional labeled diagram.                        (1 Mark)
2. If Inayah spends all of her income on consuming one good, find:                (1 Mark)
3. how much cookies she could afford?
4. how much milk she could consume?
5. 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)  
6. 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

1. Find the optimal level of consumption.
2. Find the consumer equilibrium using the two-dimensional labeled diagram.

Answer 1

• Question 02

From the information given above;

Total income = Rs.1,500

Price of milk = Rs.500 per liter

Price of a pack of cookie = Rs.300

Equation of budget is $P$_M$*M+P$_C$*C≤M$

Where,

$P$_M Price of milk

$M$ is quantity of milk

P_C is price of pack of cookie

C is quantity of cookie

At the budget line the total expenditure is equal to total income.

The budget line;

$P$_M$*M+P$_C$*C=M$

Graph representation

The above graph shows budget constrain AB. X-axis representing quantity of milk and y-Axis representing quantity of cookie.

1. 2

if inayah spends all her income on milk, she could afford;

$\text{Maximum quantity of milk=Total income/Price of milk}$

$=1500/500$

$=3 \text{litres of milk}$

1. 4

if inayah spends all her income on cookies, she could afford;

$\text{Maximum quantity of cookie=Total income/Price of cookie}$

$=1500/300$

$=5 \text{packs of cookie}$

1. 5

When Inayah's income increases from Rs.1500 to Rs.1800, the following will happen;

$\text{Maximum quantity of milk=Total income/Price of milk}$

$=1800/500$

$=3.6 \text{liters of milk}$

she could afford 3.6 litres of milk.

$\text{Maximum quantity of cookie=Total income/Price of cookie}$

$=1800/300$

$=6 \text{packs of cookie}$

She will be able to buy a maximum of 6 packs of cookies.

Here is the graphical representation

• Question 3

1. optimum level of consumption is achieved where the consumer achieves the highest level of satisfaction.

$\therefore$ Lets get the consumption bundle that maximizes utility.

$\therefore$ we have to satisfy the following conditions in order to maximize utility.

$MU$_Milk$/MU$_Cookie$=P$_Milk$/P$_Cookie

Lets assume the price of milk is Rs. 500 and price of Cookie is Rs. 300 then the condition would be;

$300(MU$_Milk$)$ $=500(MU$_Cookie$)$

At $MU$_Milk $=350$ and MU_Cookie $=150$, the identity would be satisfied.

$\therefore$ The optimum consumption is 3 packs of cookies and 2 liters of milk.

2.

consumer equilibrium is at 3 packs of cookies and 2 liters of milk. And it is represented in the budget line and indifference curve.