Question

Suppose that the price of Good 1 falls to $5 while everything else stays the same, you have an income of $40 to spend on two goods. Good 2 costs $5 as well.

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

(b) What is the slope of the budget line when the price of Good 1 and Good 2 are both $5 and your income is $40?

(c) Say that the price of Good 1 and Good 2 are both $5, but your income falls to $30. Write an equation for the budget line? What is the slope of this budget line?

Answer 1

a) Equation of budget line is given as

M= PxX+ PyY where Px is price of X and Py is price of Y and M is income.

Putting values in the equation we get

40=5x+5y

x+y= 8

Hence the budget line in simplied form is x+y=8

b) Slope of budget line is given as -Px/Py ie the price ratio of both goods.

So slope of budget line is -5/5=-1

This means that one unit of one good is given up in order to obtain an additional unit of another good.

c) When income reduces to $30, the equation is given as

5x+5y=30 or

x+y=6

The slope is still the same ie -Px/Py=-5/5=-1

Since the ratio of prices is equal the slope is the same.

(You can comment for doubts)