ims10assignment3(corercted)

ims10assignment3(corercted) - Intermediate Microeconomics...

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Intermediate Microeconomics Prof. Musatti Spring 2010 Homework 3 (20 points) – due Wednesday 02/17/10 1) A consumer with well-behaved preferences (i.e. preferences are complete, monotonic, transitive, strictly convex and continuous and indifference curves are strictly convex, the usual shape) has \$40 to spend on product 1 and product 2. Both products have a unit price of \$1. At these prices, the consumer purchases 10 units of product 1 and 30 units of product 2 . a) In an indifference curve diagram, draw the consumer’s budget constraint and represent his/her optimal choice. The local government introduces a specific tax on product 1 that raises the product’s unit price to \$2. The price of product 2 does not change. At new prices, the consumer still spends \$40 on the two products and buys 10 units of product 1. b) In the diagram, illustrate the consumer’s new budget constraint and new optimal choice (make sure his/her indifference curves do not cross!). c) In your diagram, clearly illustrate the substitution and income effect of the price increase (let me remind you that this was induced by the introduction of a tax). d) In your diagram, use a vertical segment to illustrate the tax revenue. e*) In your diagram, show that if the government taxed both products so as to keep their relative price unchanged, it could raise the same revenue at a lower welfare cost for the consumer. 2) Gasoline is a complement to most other products. Suppose a family buys one gallon of gas for every \$10 spent on other items. The family’s monthly budget is \$1,680 and the price of a gallon of gas is \$2.

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