Question

1. Suppose that a consumer can choose to purchase soap (S) at a price of Ps or waffles (W) at a price of Pw . The consumer has income M.

a. Write down the consumer’s budget constraint.

b. Suppose that the consumer’s income doubles, the price of waffles triples, and soap becomes half as expensive as it was before. Write down the consumer’s new budget constraint, in terms of the original prices and income (i.e. your answer should be in terms of Ps, Pw , and M).

c. What is the new price ratio faced by the consumer, in terms of the original prices and income (i.e. your answer should be in terms of Ps, Pw, and M)?

d. Think back to the original budget constraint in part (a). Suppose that the consumer’s income decreases, and the price of waffles increases. The price of soap remains unchanged. What must happen to the consumer’s budget set?

Answer 1

d.When consumer's income decreases and price of waffles increases the consumer can purchase less of both the goods as the budget line rotates inwards.