Question

1. You have an income of $40 to spend on two goods. Good 1 costs $10 per unit, and Good 2 costs $5 per unit.

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

(b) If you spent all of your income on Good 1, how much could you buy?

(c) If you spent all of your income on Good 2, how much could you buy?

(d) If consumption of Good 1is plotted on the x-axis and consumption of Good 2 is plotted on the y-axis, what is the slope of the budget line?

Answer 1

Budget constraint represents different combinations of two goods which a consumer can consume given his income and the prices of two goods.

(a) Let Good 1 be G1 and good 2 be G2 and price of good 1 be P1 and price of good 2 be P2. So the equation of budget constraint can be written as:

Y = P1×G1 +P2×G2 , so from the above given values,

$40 = $10×G1 + $5×G2

(b) If I spent all my income on good one, than the amount of good1 I can buy = 40/10 = 4 units.

(c) If I spent all my income on good2, than the amount of good2 I can buy = 40/5 = 8 units.

(d) If consumption of Good 1is plotted on the x-axis and consumption of Good 2 is plotted on the y-axis,

Slope of te budget line = change in consumption of good 2/ change in consumption of good 1 = 2/1 = 2.