Problem Set 1
Answer the following questions:-
1) Sheila can watch as many television programs as she wants for free, but she must pay $2
for each video she rents. Draw Sheila's budget line for TV shows (T) and videos (V), and
identify the set of affordable bundles (be sure to label the axes).
2) Suppose that there is uniform inflation by which I mean all prices increase by the same
rate r. Let there be two commodities. If P 1 and P2 are the initial prices for these two
commodities, what are the prices for the two commodities after the inflation has occured.
Show how the budget set changes. If you wanted to restore the consumers’ budget set to
what it was before the inflation without changes the prices, what could you do?
3) You have an income of $40 to spend on two commodities. Commodity 1 costs $10 per
unit and commodity 2 costs $5 per unit.
a) Write down your budget equation. Show it graphically.
b) If you spent all your income on commodity 1, how much could you buy?
c) If you spent all your income on commodity 2, how much could you buy?
d) Suppose the price of commodity 1 falls to $5 per unit while everything stays the
same. Write down your new budget equation. Show it graphically.
e) Suppose that the amount that you are allowed to spend falls to $30, while the prices
of both commodities remain at $5. Write down your budget equation.
4) Suppose a consumer has an income of $100 to spend on chocolate bars and ice-cream
cones. She faces a constant price of $1 for chocolate bars. However, the price of ice
cream depends on how much you buy. The first 10 ice cream cones cost the consumer $2
each, but every cone after that is $0.50 each. Draw the budget set. Write down the
equation of the budget line. Is the budget line continuous? Is the budget line
differentiable
5) Your budget is such that if you spend your entire income, you can afford either 4 units of
good X and 6 units of good Y or 12 units of good X and 2 units of good Y.
a) What is the slope of the budget line?
b) If you spent all your income on good X, how much X could you buy?
c) If you spent all your income on good Y, how much Y could you buy?
d) Write a budget equation that gives you this budget line, where the price of X is 1.
Write another budget equation that gives you the same budget line, but where the
price of X is 3.
6) Consider two consumption vectors: 𝑋 = (𝑥1 , 𝑥2) & 𝑌 = (𝑦1 , 𝑦2 ). It is given that XRY &
~(𝑌𝐼𝑋). The notation R stands for at least as goods or weakly preferred & I stands for
indifference. The notation ~ stands for negation. What can you say more specifically
about the relation between X & Y. Argue logically.
7) Consider two consumption vectors: 𝐴 = (𝑎1 , 𝑎2 ) & 𝐵 = (𝑏1 , 𝑏2 ). It is given that
~(𝐴𝑅𝐵). The notation R stands for at least as goods or weakly preferred. The notation ~
stands for negation. Can we say that the bundles A and B are indifferent to each other?
Argue logically.