Question

c) Consider John who consumes two goods, (X and Y), with prices 𝑃𝑥 = 𝑁$35, 𝑃𝑦 = 𝑁$25 and income I =N$1500 i) Construct budget constraint [3 marks] ii) Draw John’s budget line with good X on the horizontal axis. [3 marks] iii) Use a graph to show the effect of an increase in income from N$1500 to N$2000. [3 marks] iv) What will happen to the slope of the budget line if the price of good X decreases to N$18? [5 marks]

Answer 1

i) The budget constraint will be:

$1500=35X+25Y$

ii) The budget line for an income of $1,500 is as follows:

iii) The budget line for an income of $2,000 is as follows:

(iv)

given budget line is

$1500 = 35X +25Y$

The slope of the budget line  equals the price ratio of two products.

Slope of budget line here $= \frac{Px}{Py}= \frac{35}{25}=\frac{7}{5} =1.4$

Now when the price of X has changed to $18 and price of Y remains constant.

Therefore slope$=\frac{Px}{Py}=\frac{18}{25}=0.72$

Since slope of budget line is directly related to the price of good X, the fall in price of X will lead to fall in slope of budget line.