Question

3. If a household’s money income changes and prices do no change, what happens to the household’s real income and budget line? Explain with an example.

4. Define the Marginal Rate of Substitution. Explain how it is measured with the magnitude of the slope of an indifference curve.

Answer 1

3.A change in income results in shift in the budget line.If income rises budget line shifts to the right.A fall in income shifts the budget line to the left.

Suppose your income increases from $10,000 to $15,000 and prices of the goods you purchase does not changes.You can afford more bundles of goods with your increased income and so,your budget line shifts to the right.

4. In economics, the marginal rate of substitution (MRS) is the amount of a good that a consumer is willing to consume in relation to another good, as long as the new good is equally satisfying. It's used in indifference theory to analyze consumer behavior. The marginal rate of substitution is calculated between two goods placed on an indifference curve, displaying a frontier of utility for each combination of "good X" and "good Y."

The slope of the indifference curve is critical to marginal rate of substitution analysis. At any given point along an indifference curve, the MRS is the slope of the indifference curve at that point.

If the marginal rate of substitution is increasing, the indifference curve will be concave to the origin. This is typically not common since it means a consumer would consume more of X for the increased consumption of Y and vice versa. Usually marginal substitution is diminishing, meaning a consumer chooses the substitute in place of another good rather than simultaneously consuming more.

The law of diminishing marginal rates of substitution states that MRS decreases as one moves down a standard convex-shaped curve, which is the indifference curve.