Course Title: Microeconomics

Course Instructor: Anju Kumar

Continuous Evaluation No. 1

Continuous Evaluation Title: Assignment

Date of Allotment: 7/11/202 Date of Submission: 12/12/2020

Type of Assignment: Individual

(Individual/Group)

Student PRN Number: 20021241128

Declaration:
I declare that this continuous evaluation component is my/our original work. I have not copied
from any source or any other students work. I have acknowledged the source, if any content is
used in completion of this continuous evaluation component. I am responsible for any
discrepancies/unfair means content/copied material presented in the assignment/case analysis.

Note: Students are not allowed to disclose their identity in the assignment/case analysis/project.
Failing which lead to the unfair means practice and necessary action will be initiated.
A. Suppose a consumer has income of $10, and buys soda pop and movies. The price of
each good is $1. Draw a budget line that represents the set of bundles this individual can
afford if they use all their income. (Put movies on the X axis). Label the places where
the budget line intercepts each axis and the slope of the line.
Ans. Let, Price of Soda Pop = Px = $1
Price of Movies = Py = $1
Budget Line = Px*1 + Py*1 = 10
Budget Line = Px + Py =10

In the above Budget line PQ, the bundles are (1,9), (2,8), (3,7) …… (9,1).
And when the consumer only consumes Soda pop, at P intercept, it is (0,10)
Similarly, when only movies are consumed, at Q intercept, it is (10,0)
Slope of the Budget Line AB is -1
B. Suppose that in consumer equilibrium this individual consumes 7 soda pops and 3
movies. What rules must hold in consumer equilibrium? Label this bundle in your
drawing (call it point “A”). Draw an indifference curve associated with this bundle, and
explain how its slope at the equilibrium point relates to the slope of the budget line.
Ans. If at the consumer equilibrium, the individual consumes 7 soda pops and 3 movies, this
implies that this combination of the two products is the best possible combination that gives
him maximum utility under the budget constraints.
This is the point A which is known as the optimum.
The slope of the budget line is -1.

At the consumer equilibrium, i.e., point A

MU Movies/ Px= MU Soda/Py, where Px- price of movies and Py is price of Soda Pop.
The slope of the indifference curve at the equilibrium point is equal to the slope of the
budget line as at this point as the indifference curve is tangential to the budget line at
this point. This point is called the optimum point.
• The slope of the indifference curve is the Marginal Rate of Substitution between soda
and movies.
• The slope of Budget line is the relative price of movies and soda.
Thus, the consumer chooses the combination of the goods so that the MRS equals the relative
price.
C. Consider the bundle 2 Movies and 8 Sodas. Label this point
Ans.

The Bundle of 2 Movies and 8 Sodas is at the B(2,8) on the Graph.

D. Now suppose that income goes up to 15. Illustrate how the budget constraint will
change. If both goods are normal, explain where the new equilibrium will be (your
answer might consist of a region of bundles, rather than just one bundle).
Ans. When income increases to $15, the budget line shifts rightwards. The consumer wants
more of the goods since they are normal goods.
The consumer now shifts to a higher indifference curve and the initial optimum shifts to a new
optimum where the consumer enjoys a better combination of soda pops and movies.
 • Due to Increase in income; The Budget line has shifted rightwards from PQ to P’Q’.
• The new IC is IC’ and Optimum point is A’.

E. Now suppose the price of the Sodas increases to $2 and that of Movies remains the
same. Draw the new Budget Line and explain what the rational consumer will do in these
circumstances.
Ans. When the price of soda rises to $2 and price of movies remains $1, the budget line rotates
such that the point of intersection of the budget line on the x-axis remains the same and the
point of intersection of the budget line with the y-axis drops down.
Budget line equation:
Movies*Px + Soda Pop*Py =15
i.e., Movies + 2Soda=10
The substitution effect takes place here which makes the movies cheaper in comparison
to soda.
Hence the rational consumer will purchase more movies in comparison to soda.

• The Budget line changes from PQ to P’Q at P’=5

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