Question

OUESTİON4112MARKS) Record companies, faced with the growing competitions from digital music download services lower the price of a music CD from $18.00 to $13.50. The price of a DVD is $18. Olivias income is $216 a year and she spends all of it on music CDs and movies on DVDs a) Calculate the equation for Olivia's budget line. (3 marks) b) Draw a graph of Olivia's budget line (with CDs on the horizontal axis) (3 marks) 4 12 10 0 246 10 12 14 16 18 20 CDs (per yeor The figure above illustrates Olivia's preferences. Given the price of a CD, the price of a DVD, and Olivia's income, what quantities of CDs and DVDs does Olivia buy? Explain your solution. (3 marks) c)

Answer 1

budget line

Px*X+Py*Y = I, where Px and Py are prices of goods X and Y respectively

X and Y are quantity of goods X and Y bought respectively and I represents income

The current budget line will then be

13.5C+18D = 216

for intercept on X axis put D = 0, 13.5C = 216 or C = 216/13.5 = 16

for intercept on Y axis put C = 0, 18 = 216 or D = 216/18 = 12

so the points to plot on the graph for budget line will be (16,0) and (0,12)

Intercepts can be calculated by putting value of C and D equal to zero in the budget line.

QUESTION 4(12 MARKS) Record companies, faced with the growing competitions from digital music download services lower the price of a music CD from $18.00 to $13.50. The price of a DVD is $18. Olivias income is $216 a year and she spends all of it on music CDs and movies on DVDs a) Calculate the equation for Olivia's budget line. (3 marks) 13.50C+18D 216, where C is the quantity of music CDs bought and D represents the no of DVDs bought. b) Draw a graph of Olivia's budget line (with CDs on the horizontal axis). (3 marks) 12 10 0 2 46810 12 14 16 18 20 CDs |per yea) The figure above illustrates Olivia's preferences Given the price of a CD, the price of a DVD, and Olivia's income, what quantities of CDs and DVDs does Olivia buy? Explain your solution. (3 marks) c) Olivia will maximize her satisfaction at a point where the indifference curve is tangent to the budget line. This is the point where slope of the budget line will be equal to the slope of the indifference curve. There is only one point where the slopes are equal. Olivia can get maximum satisfaction at this point only with her current given income. Olivia can only consumer on the lower indifference curve if not chooses this point. Any point other than the equilibrium point where the slope of budget line is equal to the indifference curve will not give or maximizes satisfaction for Olivia. Olivia must choose one and only point where the two slopes are equal.

Olivia will maximize her satisfaction at a point where the indifference curve is tangent to the budget line. This is the point where slope of the budget line will be equal to the slope of the indifference curve. There is only one point where the slopes are equal. Olivia can get maximum satisfaction at this point only with her current given income. Olivia can only consumer on the lower indifference curve if not chooses this point. Any point other than the equilibrium point where the slope of budget line is equal to the indifference curve will not give or maximizes satisfaction for Olivia. Olivia must choose one and only point where the two slopes are equal.