Assignment
Topic one (Consumer Theory) Examine the economic behavior of the consumer that determines which commodities are purchased and in what quantities. What guides these individual consumer decisions? Why do consumers purchase some commodities and not others? How do they decide how much to purchase of each commodity? What is the aim of a rational consumer in spending income? How government policy can affect the individual consumption?
How do I start and what do I focus on? Here is a list of questions as guidance:
A consumer spends all her income on goods x and y. Her income is m. Prices of x and y are ???? and ????. The preferences of the consumer are represented by U(x, y) =???????? , where x and y denote the quantities of the two goods that the consumer consumes, respectively. Do not restrict your attention to integers - assume that any fraction of x and y can be consumed.
a) Write down the consumer's budget constraint and explain the concept and illustrate it on a graph.
b) Explain the concepts of the marginal utilities of x and y respectively.
c) Find the consumer's optimal consumption bundle. Show your answer in a graph.
d) Suppose that the government imposes a tax per unit on purchases of x. This means that the price of x increases to a new level. What is the new budget constraint of the consumer? Find the new optimal consumption bundle. Show your answer in the same graph as in part c.
e) Define the concepts of substitution effect and income effect. Illustrate these in your graph. Is x a normal good? Explain.
f) Compute the tax revenues (denote it by T) collected by the government. g) Which one of the schemes does the consumer prefer?