Question

Suppose Cole buys food (X) and clothing (Y) with his income of $500 per month. The prices
that Cole faces in month one are $2 per unit of food and $4 per unit of clothing. His utility-maximizing
choice is 100 food units and 75 clothing units. His preferences are convex.

Now assume that in month two, Cole's income increases by 11% to $555, the price of food increases by 5%
to $2.10, and the price of clothing increases by 15% to $4.60. Use an indifference curve-budget line
analysis to identify his choices in month one and month two. Put food on the horizontal axis and clothing
on the vertical axis. Clearly identify Cole's optimal choice in month two as (X**, Y**). (Note that you do
not have enough information to give a numerical answer for Cole’s month two choice.)

Assuming that his preferences have not changed, have the price changes made Cole better off or worse off
in month two compared to month one? Explain.

Answer 1

2015 Joa P-46 New ar mau har