Question

please answer this question in 300 words

Draw a budget constraint and indifference curves for two goods-cheese and wine. Show
what happens to the budget constraint and the consumer’s optimum when the there is an
increase in income tax by 10 percent.

Answer 1

The initial budget constraint is AB with cheese on the x-axis and wine on the y-axis. The IC1 intersects AB at E1 which is the optimal bundle. When there is an increase in income tax by 10%, the budget line shifts to the left as the disposable income of the consumer falls. The new budget line is A'B'. As disposable income falls, the new optimal bundle changes and it becomes E2 where the IC2 and A'B' intersect. Assuming both goods to be normal, the consumer would demand less of both the goods at the new optimal bundle.