Assignment - Indifference Curve Analysis

1. Joey’s budget line relating to Goods X and Y has intercepts of 40 units of Good X and 25 units
of Good Y. If the price of Good X is Rs.15, what is Joey’s budget on the two goods? What is
the price of Good Y? What is the slope of the budget line?
2. Assume that Ross has $100 per month to divide between dinners at a Chinese restaurant,
Song Hay and a pizzeria, Pizza Corner. Assume that going to Song Hay costs $20 and eating at
Pizza Corner costs $10. Suppose Ross has 2 dinners at Song Hay and 6 dinners at Pizza
Corner.
a. Draw Ross’s budget line and show that he can afford the above combination.
b. Assume that Ross gets a higher pay and can now spend $200 per month. Draw the new
budget constraint.
c. As a result of the income increase, Ross decides to eat 8 times at Song Hay and 4 times
at Pizza Corner. Draw the Income Consumption Curve. How would you classify the two
goods i.e. dinners at Song Hay and Pizza Corner?
3. What is Marginal rate of substitution? A consumer’s indifference curve contains the
following market baskets of apples and bananas.
Market Basket Apples Bananas
1 3 24
2 5 18
3 7 13
4 9 9
a. What is the consumer’s marginal rate of substitution at the different combinations?
b. Why does MRS diminish?
c. If the price ratio between apples and bananas is 2, which combination would the
consumer choose assuming she is rational?
4. Monica has a monthly budget of Rs.5000 on food and clothing. The price of food is Rs.250
and that of clothing is Rs.100. and her monthly consumption of food is 10 units and that of
clothing is 25 units. If the MRS of food for clothing (MRSFC) at this level is 3, is Monica at
equilibrium. If not, which commodity should she substitute for the other to reach
equilibrium.
5. Rachael’s marginal utilities for 2 goods X and Y are given as follows.
MUX = 60 – 6 X; MUY = 12 – 3 Y. What is the MRS when she is at a combination of
X = 8 and Y = 2. If PX is Rs.30 and PY = Rs.15, is the combination a consumption equilibrium?
6. It is given that the price of goods X and Y are both Rs.10 each, a consumer consumes 10
units of X and 10 units of Y at equilibrium.
a. Draw the budget line and indifference curve and show the point of consumer
equilibrium.
b. If the price of X falls to Rs.5, PY and money income remaining the same, what is the real
income increase?
c. At the new equilibrium caused by a fall in price of X, the consumer has a combination of
16 units of X and 12 units of Y. Show the price effect of a change in price of X using the
PCC.
d. Why are more units of Y consumed even though its price has not fallen?
7. Derive Engel’s curve from the income consumption curve for a normal good.
8. Derive the demand curve for a normal good X from a price consumption curve.