Question

3) 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

Assume Income / Consumption Expenditure = Y

Value of corn they produce = 0.3Y

Value of corn they consume = 0.8Y

a) As value of corn they consume is more than they produce, they are net buyer.

b) If price of corn rises by 20% and they buy 0.5Y of corn from market. Now they have to pay 0.5Y * 1.2 = 0.6 for the corn they buy from the market. They were left with 0.5Y of income to consume other goods before the price rise but now they are left with 0.4Y to consume other goods which results in 20% fall in purchasing power.