1.Consider a consumer who consumes only two goods: rice and beans. She has an income of k1000.00, the price of beans is k20 per kg while the price of rice is k40 per kg.
A. Suppose that the consumer comsumes k30 kg of beans. Assuming that she spends all her income. How many kg of rice is she going to consume.
B. Assume that the price of rice falls from k40 to k20. Assuming that the consumer still consumes 30 kg of beans. Find the new quantity of peas
C. Assume the income reduces to k760. Considering the new price of rice she now consumes 20 kg of beans. Find the quantity of rice she would have consumed in this case.
D. Find the substitution effect due to the decrease in the price of rice.
E. Find the income effect.
(Assignment form)
A.
Income = k1000.00
Price of beans = k20/kg
Price of rice = k40/kg
Quantity of beans consumed = 30 kg
Total expenditure on beans = Price of beans x Quantity of beans consumed = k20 x 30 = k600
Remaining income = Income - Expenditure on beans = k1000 - k600 = k400
Quantity of rice that can be bought with remaining income = k400 / k40/kg = 10 kg
Therefore, the consumer will consume 10 kg of rice.
B.
Price of rice = k20/kg
Quantity of beans consumed = 30 kg
Total expenditure on beans = Price of beans x Quantity of beans consumed = k20 x 30 = k600
Remaining income = Income - Expenditure on beans = k1000 - k600 = k400
Quantity of rice that can be bought with remaining income = k400 / k20/kg = 20 kg
Therefore, the new quantity of rice consumed would be 20 kg.
C.
New income = k760
Price of rice = k20/kg
Quantity of beans consumed = 20 kg
Total expenditure on beans = Price of beans x Quantity of beans consumed = k20 x 20 = k400
Remaining income = Income - Expenditure on beans = k760 - k400 = k360
Quantity of rice that can be bought with remaining income = k360 / k40/kg = 9 kg
Therefore, the quantity of rice consumed in this case would be 9 kg.
D.
Substitution effect = Change in quantity bought due to change in relative prices with real income remaining the same
Substitution effect = 10 kg (original quantity of rice consumed) - 20 kg (new quantity of rice consumed) = -10 kg
E.
Income effect = Change in quantity bought due to change in real income, prices remaining the same
Income effect = 10 kg (original quantity of rice consumed) - 9 kg (quantity of rice consumed with reduced income) = 1 kg