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Instructor: Justin Krieg
Econ 251 – Problem Set 3
1.
Consider the budget line below.
Income is $100 per month, and the price of the x good is
$10 and the price of the y good is $10.
Please answer the following questions.
a. Explain why bundle A is not a utility maximizing choice.
Be sure to define relative price
and marginal rate of substitution in your answer and use them in your explanation.
b. Graph the new budget line if the price of the x good falls to $5.
Find the new bundle
(
29
2
2
,
x y
graphically that maximizes utility given the change. Assume that y is a normal
good and x is an inferior (NON giffen) good. Explain why you have chosen the specific
values of
(
29
2
2
,
x y
[relative to the original equilibrium] given the income and substitution
effects related to these goods.
c. Graph the new budget line if the price of the x good rises to $20.
Find the new bundle
(
29
3
3
,
x y
that maximizes utility given this change. Assume that both x and y are normal
goods. For you new hypothetical maximum bundle indicate possible income and
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This note was uploaded on 01/09/2011 for the course ECON 251 taught by Professor Blanchard during the Summer '08 term at Purdue University.
 Summer '08
 Blanchard

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