# Analyzing The Budget Line

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Sub: Economics Topic: Micro Economics

Question:

Analyzing the budget line.

The diagram below shows the budget line and the indifference map of a consumer for two products,

food and clothing.

i) Compare the four points W,X,Y, and Z in terms of total utility and also affordability and explain why

point Z is the optimal consumption point.

ii) If there is a drop in the price of clothing, how will the budget line be affected? What will happen to

the consumption of clothing if clothing is a normal good?

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*The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for

Sub: Economics Topic: Micro Economics

Solution:

(i) Let us explain the four points mentioned in the above figure. Point W: Point W is outside the budget

line. That implies it is not affordable for the consumer to reach that point and have the respective

consumption bundles.

o Point X: Point X lies below the indifference curve. Any point below the indifference curve is

affordable but inefficient. The consumer will try to reach the maximum possible indifference curve.

o Point Y: Point Y lie in the same indifference curve as point X. That implies the consumer can

derive the same utility as point X. Point Y also lies on the budget line but it is NOT tangent to the

indifference curve. This implies that by reallocating the consumption bundle the consumer will be

able to reach higher indifference curve and thereby can obtain maximum utility. This will lead the

consumer towards point x.

o Point X: Point X is the optimal consumption point. At X, the budget line in tangent to the

indifference curve and the consumer is able to maximize his utility or level of satisfaction. At this

point the ratio of marginal utilities is same with the price ratios of the goods.

(ii). If there is a drop in the price of clothing , the budget line will shift outward towards clothing which

is shown below:

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*The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not for

Sub: Economics Topic: Micro Economics

In the above diagram, AB was the initial budget line. As there is a drop in the price of clothing the new

budget line will be AB’. The consumer will move to a higher indifference curve.

If clothing is a normal good, a fall in the price of clothing will lead to an increase in the consumption of

clothing.

** End of the Solution **

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