Question

In the following figure, a consumer is initially in equilibrium at point C. The consumer’s income is $400, and the budget line through point C is given by $400 = $100X +  $200Y. When the consumer is given a $100 gift certificate that is good only at store X, she moves to a new equilibrium at point D. (LO1, LO3, LO6) 

a. Determine the prices of goods X and Y. 

b. How many units of product Y could be purchased at point A? 

c. How many units of product X could be purchased at point E? 

d. How many units of product X could be purchased at point B? 

e. How many units of product X could be purchased at point F? 

f. Based on this consumer’s preferences, rank bundles A, B, C, and D in order from most preferred to least preferred. 

g. Is product X a normal or an inferior good?

Answer 1

A consumer has the following budget line:

(a) Price of good X is $100 and price of good Y is $200.

(b) The maximum units of good Y that can be purchased with given income is calculated as income divided by price of good.

(c) The maximum units of good X that can be purchased with $400 income is 4 units.

(d) With $100 certificate of good X, 1 unit more of good X can be purchased even if all $400 income is spent on good Y.

Therefore total of 5 units can be purchased with $500.

(e) With income of $500, 5 units of good X can be purchased if all income is spent on good X.

(f) The higher the indifference curve, the more preferred is the consumption bundle. The consumer will give first preference to point D since it lies at higher indifference curve. Then comes point B which lies below D but above point C and A. The third preference would be point C since it is the optimal point of lower indifference curve. The last is point A. The preference would be D, B, C and A.

(g) Product X is normal good since the consumer is better off with higher consumption of good X as income increases. Had it been inferior, the consumption of good X would have decreased with certificate of $100.

Answer 2

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