Question

Suppose that a consumer whose preferences are defined over two commodities has an endogenous budget consisting only of those commodities. Draw the budget constraint for this consumer so that x1 on the horizontal axis is x2 on the vertical axis. Mark the basket owned by the consumer as Point E on this budget. Let this also be the consumer's optimal solution (non-Vertex solution). how is it possible for the consumer to come to a higher level of benefit when the price of the x1 commodity increases? Show and explain in the same char

Answer 1

Let's take this to be the initial budget line and equilibrium.

Now, if the price of x1 increases, the budget line will become steeper (starting from the same point on the horizontal axis but ending earlier on the horizontal axis, representing the same quantity of x2 and less of x1 as compared to the original budget line). The new budget line is the orange one.

We can see that it is not possible to move to a higher level of benefit in this situation. In fact, the consumer will need to shift to a lower indifference curve (not shown in teh graph below).