Question

On the budget constraint and indifference curve diagram (click on it to make it bigger), if DK is the original budget line and DF is the new budget line, then which of the following must have happened to cause the move from DK to DF? The price of hot dogs must have risen. The price of Cokes must have fallen. None of the other answers is correct. The price of Cokes must have risen. The price of hot dogs must have fallen.

Answer 1

The correct option must be option 1,the price of hot dogs must have risen. To understand this we need to understand how the budget line is drawn. Let's suppose there is consumer with income Y who is consuming two goods cokes and hot dogs. Let the price of coke is Py and price of hot dogs is Px. And we have got dogs on X-axis and coke on Y-axis.

The X-axis coordinate shows the maximum amount of hot dogs that the consumer can buy, and it is calculated by Y/Px and Y-axis coordinate shoes the maximum amount of coke that consumer can buy, it is calculated by Y/Py. The initial budget line is DK. Which means that the maximum amount of coke that consumer can buy is D and the maximum amount of hot dogs that consumer can buy is K.

Now the new budget constraint is DF, which means the maximum amount of coke that the consumer can buy is D and maximum amount of hot dogs that the consumer can buy is now F, which is lower than K. Which suggests that price of hot dogs must have risen. Y/Px' is now lower, and given Y remains the same then Px'< Px.

Let's see why other options are not correct, the options involving price of coke should be eliminated straight away because the the Y-axis coordinate remains the same which suggest that prices of cokes remains the same given the income doesn't change. And we can eliminate the option in which price of hot dogs have fallen because if the price would have fallen the total amount of hot dog that consumer can buy would be increased and the X-axis coordinate will increase.