Answer to Question #297183 in Microeconomics for Bhawna

Question

Q.2 Suppose you take a job that pays $30,000 and set some of this income aside in a savings account

that pays an annual interest rate of 5 percent. Use a diagram with a budget constraint and

indifference curves to show how your consumption changes in each of the following situations. To

keep things simple, assume that you pay no taxes on your income.

a. Your salary increases to $40,000.

b. The interest rate on your bank account rises to 8 percent.

Answer 1

a) An increase in Income will cause a shift in the budget line outwards resulting in to an increase in both consumption and savings levels as shown in the below diagram.

b) An increase in interest will make me save more and this makes the budget line move outwards but remain the same for the consumption level as below.