Consumer’s Problem IV Income, Substitution and Price EffectsConsider the consumer’s problem: max U=U(x1, x2) s.t. p1x1+p2x2=m We have seen that the optimal solution to the problem leads to the utility-maximizing bundle (x1*, x2*). Figure 1 x2C m/p2A x2** R x2* P O x1* x2** m/p B D x1Now suppose that p1and p2(Figure 1) remain unchanged but m is raised to m’. We know that the new budget line satisfying p1x1+p2x2=m’ represented by the line CD will be parallel to the old budget line AB. The point of tangency B of the new budget line with a higher indifference curve represents the new 1
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