Answers%20to%20Review%20Problems%20for%20Second%20Midterm%20Fall%202009

Answers%20to%20Review%20Problems%20for%20Second%20Midterm%20Fall%202009

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Answers to Review Problem 2 Economics 102 Professor Blair Ms. Anthrope has a disposable income of $10 per week and spends it all on fish and bread. Currently the price of fish is $2 per pound and the price of bread is 50¢ per loaf. Her indifference curves are shown below. 1. Draw her budget line in the diagram. What is the equation for this line?
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Let M = income, P F = price of fish, P B = price of bread, X F = quantity of fish demanded, X B = quantity of bread demanded. Then the budget constraint can be written as M = P F X F + P B X B , and rewriting in terms of X B gives X B = - (P F /P B ) X F + (M/P B ). The budget line shows the quantities of goods available to a household given its income (M) and the prices of goods it buys (P F , P B ). Note that the slope of the budget line is the negative of the ratios of the prices. The opportunity cost of fish in terms of bread is measured by the slope of the budget line and also by the relative price ratio (P F /P B ). For the given prices (P F = 2, P B = .5) and income (M = 10), the budget constraint is X B = - 4 X F + 20 It is plotted in the diagram in blue . 2. Given her income and the prices of the two goods, how many pounds of fish and how many loaves of bread will she buy? Because Ms. Anthrope wishes to choose her most preferred bundle, she consumes a bundle of commodities on her highest attainable indifference curve. An indifference curve shows all combinations of fish and bread that yield equal satisfaction and among which Ms. Anthrope is indifferent. Her most preferrred bundle is the point at which an indifference curve is tangent to the budget line. At such a tangency position, the (negative of the) slope of the indifference curve (marginal rate of substitution for the 2 goods) is the same as the (negative of the) slope of the budget line (relative price of the goods in the market). Inspection of the graph shows the consumption bundle (2.5, 10), i.e., 10 loaves of bread and 2.5 pounds of fish to be the most preferred combination. 3. Why doesn’t she buy more of both goods? Given her income and given prices P B and P F , any combination to the northeast of (2.5, 10, that is, more of both goods, is not affordable. 4. Why doesn’t she buy more fish and less bread? The combination (2.5, 10) is the point where her highest attainable indifference curve is tangent to the budget line. It is therefore impossible to reach a higher curve by moving along the budget line. If Ms. Anthrope did alter her consumption bundle by moving away from (2.5, 10) but staying on the budget line, she would move to a lower indifference curve, and thus lower her level of satisfaction.
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5. Using the indifference map, estimate the quantity of fish and bread Anthrope will purchase when the fish price is $2, $1, and 50¢. Draw a graph and plot these prices and quantities to show her demand curve for fish. Thus, when p
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This note was uploaded on 03/08/2011 for the course ECON 220 taught by Professor Cai during the Spring '08 term at Rutgers.

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Answers%20to%20Review%20Problems%20for%20Second%20Midterm%20Fall%202009

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