Question 1
The price of food xF is pF = $10 per unit. The price of entertainment xE is pE = $8. You have a
monthly income of m = $7, 000.
(a) For each of the questions, use the strict definition of the items in bold given in the lecture
and in Varian chapter 2. (i) Write down your budget constraint for the month, explaining the
components. (ii) Derive your budget line written in the form where food is on the LHS. (iii)
Draw a graph (with food on the vertical axis) indicating your budget line, your budget set, the
maximum spending you could make on food, and the maximum spending you could make on
entertainment. Explain your answers.
(b) Repeat part (a) if the price of entertainment falls to $6. Explain how and why this graph differs
from that in part (a).
(c) Repeat part (a) if your income then falls to $6, 500 (after the change in part (c)). Explain how
and why this graph differs from those in parts (a) and (c).
(d) Graph the bundles of goods that you could afford in part (a) but could not afford in part (c) and
vice versa.
Question 2
Graph the budget constraint over two goods, for each of the following situations:
(a) The price of good 1 is $16, the price of good 2 is $10, income is $35, 000.
(b) Good 1 is free, the price of good 2 is $500, income is $50, 000. Explain the shape.
(c) The price of good 1 is $8, the price of good 2 is $20, income is $45, 000. Explain how and
why this graph differs from that in part (a).
(d) Both goods are free. Explain the shape.
(e) Goods 1 and 2 have equal prices, income is 100 times the price (of a unit of either good).
Question 3
You are a small consumer compared to the market, and therefore your individual consumption
decisions do not affect prices. If you spend all your money on food and entertainment, you can
afford 300 units of food and 1, 000 units of entertainment in a given period, or 400 units of food
and 950 units of entertainment.
(a) (i) Derive the price ratio between food and entertainment. (ii) Find the maximum expenditure
that can be made on food. Explain your working.
(b) How much entertainment could you purchase with all your income? Explain.
(c) Write two distinct budget lines that give you the budget constraint from part (a). What is the
relationship between the two?Explain