Question

27. Assume that the budget constraint in Figure 7.1 panel A is: PEE+PAA - I, where I is total income and PE is the price of education and PA is the price of all other goods, If U(E,A) - A+E, PE = 2, PA = 1, and I - 10 what is the quantity of education and all other goods consumed?
Please help me i dont know what to do.. thanks

Answer 1

U(E,A) = E + A

$\partial$U/$\partial$E = MU_E = 1

$\partial$U/$\partial$A = MU_A = 1

MRS _E,A =   MU_E/ MU_A

= 1/1

= 1

Price ratio = P_E/P_A  

= 2/1  

= 2

Since MRS _E,A = 1 <  P_E/P_A = 2 which means only A will be consumed and E = 0

P_EE + P_AA = I

P_E(0) + P_AA = I  

Thus, A = I/P_A  

= 10/2

= 5

Hence optimal bundle {E,A} = {0, 5}