ANSWERS to Questions 3‐5/ Discussion 4Answer to Q.3a)If MRS is higher than the price ratio21PP, then Kate will only spend her money on good 1. If212,1PPMRS<, than she spends her money only on good 2. If21PPMRS=, then any bundle on thebudget line is optimal. Kate’s MRS equals‐2. Hence the demand functions are:,2_,02_],,0[2_,212112111⎪⎪⎪⎩⎪⎪⎪⎨⎧>=<=ppifppifpmppifpmx,2_,02_],,0[2_,212122122⎪⎪⎪⎩⎪⎪⎪⎨⎧<=>=ppifppifpmppifpmxb)p2=1, m=10At any price higher than 2 (p1>2), Kate only buys good 2. Hence for x1=0, x2=10. Fo p1=2, the budget linehas the same slope as the indifference curves, so any point on the budget line will be optimal:(the BL, for p1=2). For p1<2, Kate only buys good 1. Hence for x1>5, x2=0. The price offercurve is:12210xx−=,5__,05__,2101112⎩⎨⎧≥<−=xifxifxxTo find the demand curve, we plug p2and m into the demand functions from part (a):
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