A consumer wants to consume two goods. The prices of the two goods are Rs. 4 and Rs. 5 respectively.
A consumer wants to consume two goods. The prices of the two goods are Rs. 4 and Rs. 5 respectively. The consumer’s income is Rs 20.
(i) Write down the equation of the budget line.
(ii) How much of good 1 can the consumer consume if she spends her entire income on that good?
(iii) How much of good 2 can she consume if she spends her entire income on that good?
(iv) What is the slope of the budget line?
1 Answers
(i) P1 = Rs 4
= Rs 5
M = Rs 20
Equation of the budget line = P1 x x1 + P2 x x2 = M
4x1 + 5x2 = 20
(ii) If Rs 20 is entirely spent on good 1, then the amount of good 2 demanded will be zero i.e., x2 = 0, as the consumer has no income left to spend on good 2.
4x1 + 5(0) = 20
4x1 = 20
x1 = 20/4
x1 = 5
Amount of good 1 consumed = 5 units
(iii) If Rs 20 is entirely spent on good 2, then x1 = 0, as the consumer has no income left to spend on good 1.
4(0) + 5x2 = 20
5x2 = 20
x2 = 20/5
x2 = 4
Amount of good 2 consumed = 4 units
(iv) Slope of the budget line = - P1/P2
= - (Price of good 1)/(price of good 2) = - 4/5
= - 0.8