Question

(a) A consumer has the following budgetrestriction: PEF + PCC=1 Illustrate this restriction in a figure with the two goods C and F on the axis. Explain and show how it changes when Pc increases. Explain and show how it changes as I decrease. (b) Illustrate a consumer's optimal choice in the same type of figure. Explain in detail why the optimal point is optimal. (c) Illustrate and explain the change in the optimal consumption when a price changes. Transfer information from this figure to another figure, to generate a demand curve. (d) What is an Engel Curve? Illustrate in a figure. Explain how different groups of goods are classified according to the slope of the Engel Curve.

Answer 1

Page 4 Sold_© suppose, the price of good G decreases, so the recal income available for consumer increases. Due to this the budget line moves from I to Il as in fig.4. Thus, due to decrease in price of C, thie consumer is better off and moves to a new indifference Curve CIC) and a new optimum point (E). Fig.5 F Fig.5 shows that due to decrease in price of Cythe consumer is able to consume more of both goods F and c at new optimum point E as evident from Fig5 -

Page 5 2 Sol-d): Engel curve is named after the German statistician Ernst Engel. Engel curve depict the relatiership between goods esependituce and income of an individual. Let'us represent income on the vertical axis and quantity demanded for goods on the horizontal equis. Figs (a) curve - Engel curve Income L3 Demand demand Necessities Luxury goods From Fig.6, it is evident that if the good is for necessary conscaiption, teen the Engel wreve in concave down Watch boxer bordure and cu word eloping. The change inslope of Engel curve in this case is less élastic. While incase of Luxury goods, the slope of the Engeleceve is more elastic. The Engel cutive in this case in upwared sloping and convex downwards. However, in case of inferior goods, Engel curve in boackward bending oft shows a negative relation between income and demand For inferior goods. See page-6..

Page-se Fig.7 - Infettior goods Dale Engel cutive YA and Ancona NOV -Demand tilan

Page - Solution : (a) As per the question a consumer faces the Following budget restriction?' Pp F + PeC = ! here, If and Pe are respective market prices of goods F and C . And, I stands for Income of the consumer. Further, the budget restriction suggests that out preces Pf and Pes the consumer can purechase various combina- tions of goods f and C given the level of income The original; budget restriction is depicted DD in figured below, take builo FRPFF of Peci Pec Ć Goods and and C are consumption choises. along the Y and X-axis. Thus, with the initial prices Pc, the consumer can purchase a total of OPC amorint of goods White it the consumen allocates histher total income However, in case of increease in Price of goode PTO.

Page 2 Also, it the consumer faces a decrease in income (1), the the budget line shiste beytword meaning that the consumere has less income to spend on goods Fand. This is shown in the figure 2 and The decrease in income is shown through a lechwered shift in budget the Facom I to I'.

consumpleón bundle Page 3 Soln- A consumere's optimal consumption of two goods takes place it the indifference curve is tangent to the budget line. An indifpercence shows the motor different combination of goods F and C gives the consumer same satisfaction as all the combination of the goods F and c live on the same indifference curve. The optimal point is the tangency point it), Where the mag marginal rate of substitution between good F and good c (slope of indifference cureve) equals the reelative price of the two goods. This is shown below in Fig. 3 2 . Fig.3 Indifference curve d . The optimal point is e.