This preview shows pages 1–4. Sign up to view the full content.

Chapter 3 Practice B - Answers 1. Suppose Peggy consumes only 2 goods, gasoline and cigarettes. Her income is \$120, the price of cigarettes per pack is \$4 and the price of gasoline per gallon is \$2. Currently, she consumes 40 gallons of gas. Sketch the following budget constraint. (Put gas on the horizontal axis.) Be sure to show how you calculated the slopes and intercepts. a. Graph this budget constraint first, before doing each of the following. Using an arbitrary convex indifference curve, indicate that the current consumption combination is optimal. How many packs of cigarettes should she consume? 10 packs of cigarettes equation for budget constraint: C = I/P C – (P G /P C )G = 30 – ½ G G = 40 C = 10 b. If the government imposes a sales tax of \$1 per unit on gasoline, Peggy will consume 28 gallons of gas. How many packs of cigarettes should she consume? 9 packs of cigarettes new intercept on G-axis: I/(P G + 1) = 120/3 = 40 new equation for budget constraint: C = 30 – ¾ G G = 28 C = 9

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
c. What happens to the budget constraint if the \$1 sales tax applies only to purchases of gasoline in excess of 20 gallons? (do not show an indifference curve for this one) d. In addition to the above prices (no sales tax) and income, Peggy is given 10 packs of cigarettes, which she cannot sell. (do not show an indifference curve for this one) e. What happens if instead Peggy can sell the 10 packs at \$4 each (assume there’s no tax)? (do not show an indifference curve for this one) I = 120 + (10)(4) = 160 new equation for budget constraint: C = 40 – ½ G
2. Given Mary’s current consumption of beer and French fries, her MRS of beer is 3 bags of French fries. The market price of French fries per bag is \$1 and the market price of beer per bottle is \$2. a. Graph the budget constraint, putting beer on the horizontal axis. What is the slope of the budget constraint? slope of budget constraint = F B P P = 1 \$ 2 \$ = 2 b. On the same graph, draw in the current indifference curve and indicate the current consumption bundle. MRS = 3 >

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.