Economic Analysis

Economic Analysis

Section 1

Problem 1- Peter consumes two goods, clothing and food. He has $40 to spend on the two goods. The price of food is $10 and the price of clothing is $20.

Write the equation for Peter's budget constraint.

Ans1- A budget constraint has the representation of all the goods and services that are used by consumers at given current prices within their income bracket. The concept of Consumer Therapy is important in defining concept and the creation of a preference map for analyzing consumer choices. In this particular case, Peter has the option to consumer two goods that are clothing and food. The total income to be spent on this good is $40 but he has total expenses of $30 that includes the price of food, $10 and price of clothing is $20. The equation for the Peter's budget constraint would be written as:

PxX+ PyY= m

20,0+ 10,0= 30

Graph Peter's budget constraint with food on the x-axis.

The graphical representation is important in the determination of the budget constraint values. It provides an idea of the total consumption and total expenditure for the consumer. A graphical representation is drawn as the reference towards the budget constraint in the next page. A typical graphical representation of the Budget Constraint is:

Figure 1: Budget Constraint Example

The above picture is the just an example of the graphical representation. In the case of Peter, Product Food would represented in the Y-Axis with Good Y and it would be written as A (0, 10). Product Clothing would be represented in the X-Axis with Good X and it would be written as B (20, 0).

c. These are regular convex indifference curves. What are the conditions that must be satisfied at Peter's optimal consumption bundle?

Ansc- The indifference curves are referred as the curves that have downward sloping. This happens because of the loss of consumption in one good for acquiring the additional consumption of the other good. The indifference curves are convex to the origin which reflects the fact that the consumers generally prefer variety of goods. The indifference curve refers to the variety of points at which a consumer gains a certain level of utility. The conditions that need to be satisfied for obtaining Peter's optimal consumption bundle have strong relationship with the Budget Constraint Equation. When the price of the good changes, the optimal consumption bundle has a major affect in this regard. For instance if the price of Clothing would increase, the demand would decrease and that amount can be used to buy the additional item of Food. The graphical representation and the indifference curve might be that when Clothing equation would be (4, 16), it means that the scope for the Additional Food will have a higher impact. The indifference curve will have a downward sloping trend. This is the general example of an indifference curve for achieving an optimal consumption bundle.

Figure 2: Example of an Indifference Curve

d. Using the table below, find Peter's optimal consumption bundle and ...