Question

In a developing country, there is a poor household that owns a small land on which they grow corn. They eat part of the corn and sell the rest of it.
The value of corn a household produces (when valued at the market price) is the equivalent of 30 percent of its income or consumption expenditure and the value of the corn it consumes (when valued at the market price) is the equivalent of 80 percent of its consumption expenditure.

a) Is the household a net buyer or net seller?

b) By how much does the household’s real purchasing power increase/decrease if the price of
corn rises 20 percent? Calculate!

Answer 1

a) The household is a net buyer because it consumes more than it produces. Suppose the income or consumption expenditure of the household is X. Then, production of corn by household = 0.3X and consumption = 0.8X. Hence net purchase of corn by household = 0.8X-0.3X = 0.5X. Thus the household is a net buyer.

b) The increase in price of corn by 20% will increase the purchasing power according to production by (0.3X)*20% = 0.06X

Also The increase in price of corn by 20% will decrease the purchasing power according to consumption by (0.8X)*20% = 0.16X

Thus there will be net decrease in real purchasing power of (0.16-0.06)X = 0.1X. Thus real purchasing power will decrease by 20%.