Question

Imagine that you, a college student, have a budget of $1000. You can spend this money on sweaters
($50 each) or “all other goods” (think of this as money, with a price of $1).

(a) Write your budget equation using s for sweaters and x for all other goods. Draw your budget
constraint (with sweaters on the vertical axis).

(b) Imagine that your aunts give you a gift of $500 in cash (total). Write your budget equation. Draw your
new budget constraint. Shade the set of bundles you can afford now that you couldn’t afford before. Are
you probably happier than part (a)? Why?

(c) Imagine that instead your aunts give you a total of 10 sweaters (value: $50 each) and you can trade
them in for their market value to buy other goods. Write your new budget equation. To get there, start by
putting your endowment on the right-hand side of the equation (but now your endowment is not just
money…). Draw your new budget constraint. Are you probably happier than part (a)? Than part (b)?
Why?

(d) Finally, imagine instead that your aunts gave you a total of 10 sweaters ($50 value each) but you
CANNOT trade them in because your aunts will be angry. Write your new budget equation and the
associated constraint. Draw your new budget constraint. Are you probably happier than part (a)? Than
part (c)? Why?

Answer 1

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