Reference no: EM13894491

a) The budget line corresponds to all baskets that cost the same as the consumer's income. The budget line therefore defines her possible consumption choices.

b) Since we have 30 and the price of good 1 is 10, we can maximally consume 3 units of good

1. The price of good 2 is 15, so we can maximally consume 2 units of good

2. We indicate these points on the axes (see Figure S.1.3) and draw a straight line between them. The area on and under the line corresponds to all baskets we can consume.

c) The relative price will define the slope of the budget line (which is p1/p2). The income will affect the distance of the budget line from the origin.

If the price of good 1 falls, we can consume more of it. Say that the price falls from 10 to

d. Then we can maximally buy 5 units of it. Consequently, the budget line rotates to the broken line in the figure.

If income increases, we can consume more of both goods. Say that the income increases to 40, but that the prices remain the same. Then we can maximally consume 4 units of good 1 or 2.7 units of good 2. Consequently, the whole line shifts outwards to the dotted line in the figure.