Question

Sue has $120 to spend on movies and dinners this month. The price of a dinner is $20 and the price of a movie is $10.

a. Draw the budget constraint with dinners on the x-axis and movies on the y-axis.

b. Graphically show Sue’s utility-maximizing bundle, assuming that both goods are normal goods.

c. Graphically show Sue’s utility-maximizing bundle, assuming that dinner is a normal good and movie is an inferior good.

d. If the price of a dinner decreases from $20 to $10, draw the new budget constraint with dinners on the x-axis and movies on the y-axis.

e. Assume that both goods are normal goods.

i. The substitution effect of the increase in price of a dinner will make her consume (more/less) dinners.

ii. The substitution effect of the increase in price of a dinner will make her consume (more/less) movies.

iii. The income effect of the increase in price of a dinner will make her consume (more/less) dinners.

iv. The income effect of the increase in price of a dinner will make her consume (more/less) movies.

Answer 1

Answer a)

Answer b)

Point A will be the maximum utility achived at this price.

Answer c)

In the above graph indifference curve intersect budget line above A is the new point of maximum satifaction

Answer d)

Note:

In all the above graph Movies on Y axis and Dinner on X axis.