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PS2+solution

# PS2+solution - Rice University Professor Diamond Economics...

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Rice University Economics 370 Professor Diamond Microeconomic Theory SOLUTION TO PROBLEM SET 2: BUDGET SETS AND PREFERENCES AND UTILITY AND CHOICE I. Suppose that a consumer faces a budget line p 1 x 1 + p 2 x 2 = m . Then price of good 1 triples, the price of good 2 becomes six times larger, and income becomes nine times larger. 1. Write an equation for the new budget line. The original budget constraint is p 1 x 1 + p 2 x 2 = m m x 2 = p 2 p 1 p 2 x 1 . And the new budget constraint is 3 p 1 x 1 + 6 p 2 x 2 = 9 m x 2 = 9 m 1 6 p 2 3 p 1 x 6 p 2 x 2 = 3 m 2 p 2 p 1 2 p 2 x 1 . 2. Draw the new budget line on the same graph as the first. X 2 3m/2p 2 m/p 2 the original b.c. the new b.c. m/p 1 3m/p 1 X 1 So the new budget line is flatter reflecting the reduction in p 1 /p 2 , but further from the origin reflecting the increase in the x 2 intercept from m/p 2 to (3/2)m/p 2 . II. Suppose the price of electricity is \$7 per 100 kwh (h-kwh) per month. There is no tax for the

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PS2+solution - Rice University Professor Diamond Economics...

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