Question

On ONE diagram and using budget constraints and indifference curves, illustrate the following:

      (a) Lavenda spends $400 on widgets every semester. Widgets sell for $20 each.

(b) A tax on widgets increases its price by 50%. Lavenda complains about the price increase but keeps on buying the same quantity as before.

(c) To stop her endless complaints her friend Balkaran offers her $200. Is Lavenda better or worse off after the price increase and Balkaran’s offer?

      (d) Does her consumption of widgets increase or decrease?

On ONE diagram and using budget constraints and indifference curves, illustrate the following:

      (a) Lavenda spends $400 on widgets every semester. Widgets sell for $20 each.

(b) A tax on widgets increases its price by 50%. Lavenda complains about the price increase but keeps on buying the same quantity as before.

(c) To stop her endless complaints her friend Balkaran offers her $200. Is Lavenda better or worse off after the price increase and Balkaran’s offer?

      (d) Does her consumption of widgets increase or decrease?

Answer 1

a)

Lavenda spends 400 on widgets which is selling for 20.

So it can be said that Lavenda is buying 400/20 = 20 widgets.

b)

Price increases by 50%, so new price is 20 + 50%*20 = 30.

Lavenda still buys 20 widgets, costing 20*30 = 600.

Indifference curve moves left.

c)

Friend offers 200.

Lavenda spending higher amount due to increase in price = 600 - 400 = 200.

So Lavenda is neither better off or worse off according to the spending.

Indifference curve moves to the right. So, Lavenda is better off according to the indifference curve (utility).

d)

Consumption of widgets still remains same.