1. A person has $ 100 to spend on two goods X and Y whose respective prices are $3 and $5.
A. Draw the budget line.
B. What happens to the original budget line if the budget falls by 25%?
C. What happens to the original budget line if the price of X doubles?
D. What happens to the original budget line if the price of Y falls to $4?
A. To draw the budget line, plot the points (0,20) and (33.33,0) on a graph where the x-axis represents the quantity of good X and the y-axis represents the quantity of good Y. Joining these points will give you the budget line.
B. If the budget falls by 25% to $75, plot the points (0,15) and (25,0) on the same graph. Joining these points will give you the new budget line, which will be parallel to the original budget line but shifted downward.
C. If the price of X doubles, the new price of X will be $6. To draw the new budget line, plot the points (0,16.67) and (16.67,0) on the same graph. Joining these points will give you the new budget line, which will be steeper than the original budget line.
D. If the price of Y falls to $4, to draw the new budget line, plot the points (0,25) and (20,0) on the same graph. Joining these points will give you the new budget line, which will be flatter than the original budget line.