Question

Brian consumes units of electricity (E) and a composite good (Y), whose price is always 1. he likes both goods. in period 1 the power company sets the price of electricity at $7 per unit, for all units of electricity consumed. Brian consumes his optimal basket, 20 units of electricity and 70 units of the composite good. in period 2 the power company then revises its pricing plan, charging $10 per unit for the first 5 units and $4 per unit for each additional unit. Brians income in unchanged. Brians optimal basket with this plan includes 30 units of electricity and 60 units of the composite good. in period 3 the power company allows the consumer to choose either the pricing plan in period 1 or the plan in period 2. Brians income in unchanged. which pricing plan will he choose? illustrate you answer with a clearly labeled graph.

Answer 1

(as per above labled graph ) his initial budjet line is the solid curve RJ

.his initial optimal basket is A

His new budget line is the dotted,

piecewise linear curve RST. He chooses basket B,

which costs10(5) + 4(30-5) + 1(60) = 210.

In period 2 Basket A costs (10)(5) + (4)(20– 5) + 1(70) = $180, so Basket A lies inside the new budget line.

In period 3 Brian will choose the plan from the second period. B is weakly preferred to a basketlike C, which, in turn is strictly preferred to A (because C lies to the northeast of A). Thus hestrictly prefers B to A, and he can only reach B by choosing the plan from perod2