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# AnsD4 - ANSWERS to Questions 35 Discussion 4 Answer to Q.3...

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ANSWERS to Questions 3 5/ Discussion 4 Answer to Q.3 a) If MRS is higher than the price ratio 2 1 P P , then Kate will only spend her money on good 1. If 2 1 2 , 1 P P MRS < , than she spends her money only on good 2. If 2 1 P P MRS = , then any bundle on the budget line is optimal. Kate’s MRS equals 2. Hence the demand functions are: , 2 _ , 0 2 _ ], , 0 [ 2 _ , 2 1 2 1 1 2 1 1 1 > = < = p p if p p if p m p p if p m x , 2 _ , 0 2 _ ], , 0 [ 2 _ , 2 1 2 1 2 2 1 2 2 < = > = p p if p p if p m p p if p m x b) p 2 =1, m=10 At any price higher than 2 (p 1 >2), Kate only buys good 2. Hence for x 1 =0, x 2 =10. Fo p 1 =2, the budget line has the same slope as the indifference curves, so any point on the budget line will be optimal: (the BL, for p 1 =2). For p 1 <2, Kate only buys good 1. Hence for x 1 >5, x 2 =0. The price offer curve is: 1 2 2 10 x x = , 5 _ _ , 0 5 _ _ , 2 10 1 1 1 2 < = x if x if x x To find the demand curve, we plug p 2 and m into the demand functions from part (a):

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