Question

This question allows you to evaluate how to think about the welfare of consumers. Assume a consumer's welfare is driven by what he/she consumes. Suppose there are only two types of goods to consume: food and leisure. An average Californian citizen has a daily income of $100. The price of one meal of food is $20 and the price (or value) of one unit of leisure is $10. An average citizen in Mississippi has a daily income of $50. The price of one unit of food is $10 and the price (or value) of one unit of leisure is $10. Who is more well-off in terms of the bundles of goods they can consume? (hint: draw budget sets.) Suppose you earn $100 per day. One day your boss increases your income by 50% solely due to your high performance at work. Are you more well-off, worse-off, the same, or cannot answer compared to before the change? Suppose the boss had lied to you. The reason why she increased your salary by 50% is because all other prices also increased by 50%. Are you more well-off, worse-off, the same, or cannot answer compared to before the change? Suppose you are a big fan of Japanese food and Chinese food and those are the only two goods you consume. Suppose your income does not change and the price of Japanese food decreases. However, the price of Chinese food increases. Are you more well-off, worse-off, the same, or cannot answer compared to before the changes in prices?

Answer 1

3.

Suppose that the initial budget line of the consumer is

$M=P_c.C+P_J.J$

C and J is the amount of Chinese and Japanese food consumed by the consumers respectively. The Pi 's are the respective prices. The initial budget set of the consumer was AOB. As the cost of good J decreases and that of good C rises, the budget line pivots clockwise making the new budget set as COD. Now after the price rise, the consumer can buy less of good C with all his income (C axis intercept) and more of good J (J axis intercept). Then the area DeB is no longer affordable but area AeC becomes available. Then the effect of the total change on consumer welfare is ambiguous. This can only be solved with the known consumer preference only.