Question

Suppose the price of good 1 and good 2 are p₁ = 3 and p₂ = 10, respectively. The government applies an ad valorem tax t = 0.8 to every unit of good 2 that is bought in excess of 7. Suppose a consumer has an income of m = 99. What is the maximum amount of good 2 he/she can afford?

a. 9.17

b. 5.50

c. 7

d. 8.61

e. None of the answers is correct

f. 9.69

g. 9.90

Answer 1

The correct answer is (f) 9.69

In order to calculate maximum amount of good 2 he/she can afford We have to take quantity of good1 = 0.

Now, Suppose he spend all his income on good and p2 = 10 till quantity = 7 and after that p2 will become 10 + t = 10.8. Given Income (m)= 99.

hence with this information after purchasing 7 units amount of income remaining = 99 - 7*10 = 29.

Till now he has purchased 7 units and now p2 = 10.8 and income remaining = 29. hence If he spend 29 on good 2 then now he can purchase 29/10.8 = 2.68 more.

Hence Amount of good 2 that he/she can afford = 7 + 2.68 = 9.69

hence, the correct answer is (f) 9.69