NAME- TANIYA CHORDIA PRN- 21060322163

You have studied about the Budget Constraints which is as follows:

Px X + Py Y = M, where;
Px : Price of good X Py : Price of
good Y
X and Y are two commodities. M
Income of the consumer.

Good X and Good Y are taken on the Horizontal and Vertical Axis respectively. The above
Budget Line can be
represented in the standard form of Y = mX + c, where Y is the Good Y, X is Good X. m is the
slope which of
the above Budget Line is –Px/Py.

Step 1.
Using the above concept formulate the Budget Line of the following information:

There are two time period: Current (Period 1) and Future(Period 2). You as a consumer
consumes two goods
which are Current Consumption (C1) and Future Consumption (C2). You have Income M1 in the
Current
Period and M2 in the Future Period. You also earn certain interest rate on your saving which you
make in
Period 1 and use that for the consumption in Period 2.
Form the Budget Line using the information:

1. Consumption in Period 2 is equal to Income in Period 2 plus the saving in Period 1 and also
the
interest earned on that saving.
2. Your income in the Current Period is Rs.500 and Income in Future Period is Rs.792.
3. Your Current Consumption (C1) and Future Consumption (C2) should be treated like Good X
and
Good Y.
4. r is the interest rate earned on your saving which is 10%.

Using the four points given above find the Budget Line and also specify the slope and the
constant term and
two goods X and Y. Also, plot this Budget Line.
Step 2.
Once you get you Budget Line in Step1, proceed with this step. Your utility function is given by

U = x1/2 y
1/2

Where x and y denotes the current and future consumption respectively.

Maximize your utility and determine the optimum consumption expenditures in two periods
subject to budget
constraint you have got in Step1.

STEP 1

The question states the following:

- Consumption in Current Period/ Period 1 (C1)= X
- Consumption in Future Period/ Period 2 (C2)= Y
- Income in Current Period (M1)= Rs 500/-
- Income in Future Period (M2)= Rs 792/-
- Interest Rate on Savings (S)= 10%

To find final amount of savings with 10% Interest Rate-

Therefore,
Slope of the Budget Curve= -Px/Py= -1.1/1= -1.1

Constant= 1342 To plot the budget line,

Quantity of Good X/ X intercept= M/P1= 1342/1.1= 1220
Quantity of Good Y/ Y intercept= M/P2= 1342/1= 1342
STEP 2

This optimization problem can be solved using the Lagrangian theorem-

And in step 1 we have found the budget constraint which is 1.1x+y= 1342
Therefore, we want to maximize the utility function U = x1/2 y1/2 subject to the constraint
1.1x+y= 1342
- First, we have to set the budget constraint equal to 0, which is= (1342-1.1x-y)=0
- The Lagrangian function can then be defined as L= (utility function) + λ (Budget Constraint) L
(x,y,λ)= x1/2 y1/2 + λ (1342-1.1x-y)
Next, we calculate the partial derivatives with respect to the three variables to obtain the
first-order conditions of the optimization problem.
→Therefore, the Optimum consumption expenditure is 610 and 671.