Question

Suppose that Jessica has income Y and has preferences over hamburgers and movie tickets. Her budget constraint is: Y = Ph*h+Pm*m. Where Ph and Pm denote the price of hamburgers and movie tickets and h and m their quantity. Assume that Jessica's income is equal to $400 and that each hamburger costs $4 and each ticket costs $8. Draw the budget constraint as well as an indifference curve that satisfies the condition for utility maximization. Please fully label the graph. Suppose that Jessica's income has increased to $800 while prices for both goods remain the same. Draw the new budget constraint and the new point where utility is maximized. Is the new level of utility higher or lower than before? Now suppose that after the increase in income, the price of hamburgers increases too. Show in a graph the new point where utility is maximized and explain in words what you would expect to happen. Hint you can break the net effect into two separate effects and then assume what kind of good hamburgers are to determine the net effect.

Answer 1