Answer to Question #158771 in Economics for Samahir

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:  

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) The equation of the budget line is:

500Qm + 300Qc = 1,500.

b) If Inayah spends all of her income on consuming one good, then: i. she could afford 1,500/300 = 5 packs of cookies,

ii. she could consume 1,500/500 = 3 liters of milk.

c) An increase in the income from Rs. 1,500 to Rs. 1,800 will increase Inayah’s consumption level.

d)

i. The optimal level of consumption is at MUm/Pm = MUc/Pc.

The almost optimal level is reached, when Qm = 2 liters of milk and Qc = 2 packs of cookies.

ii. The consumer equilibrium using the two-dimensional labeled diagram can be shown as intersection point between the budget line and the indifference curve.