Question

Say that you have an income of $300, all of which you spend on 2 goods: x1 and x2. The price of x1 is $1 and the price of x2 is $10.

(a) (2 POINTS) Write down an equation for your budget constraint.

(b) (2 POINTS) If the consumption of x1 is plotted on the xaxis and the consumption of x2 is plotted on the yaxis, what is the slope of the budget constraint?

(c) (3 POINTS) What is the minimum quantity subsidy of s on x2 that makes the consumption bundle of 20 units of x1 and 20 units of x2 a§ordable to you if your income is $300, the price of x1 is $1; and the pre-subsidy price of x2 is $10.

(d) (3 POINTS) Say that the government imposes a quantity tax of t on the consumption of x1. If you spend all of your $300 income on x1 and the pre-tax price of x1 is $1, you can a§ord to buy 100 units of x1 after the tax is imposed. What is the numerical value of t

Answer 1

Please refer to the image below for the solution of parts a, b and c.

d) Quantity tax is a physical limit on the physical quantity of goods and services sold, that is what it is proportional to the quantity of good sold, regardless of its price. In this case, the limit is set on the consumption of X1. So after tax, we can buy only 100 units of X1 for consumption even though we spend all of our income this means that the quantity tax "t" imposed is equal to 100 units of X1. In the above image, the point-B in the figure for Budget line depicts the level of consumption of both the goods in this case.