Im trying to get through some economics questions so im prepared for
my test. The questions posted are the ones I have been having some
trouble with. Please answer them and include graphs wherever they
would be helpful in explaining the question proposed.

I need an answer by 4/7 at 3:30-4:00PM... please leave a message here
if you have any questions. Thanks!

QUESTION:
Assume a consumer has an income of $250, the price of X1 is $10 and
the price of X2 is $8.  Draw the set of all feasible combinations that
can be consumed.  What happens to the graph if the price of X2
decreases to $5.  Show an individual maximizing their utility after
the price change.  How much of X1 and X2 are consumed at that utility
maximizing point.  How do you know their utility is maximized where
you drew it.  Can you derive a demand curve for X1? For X2?  If you
answered yes to the preceding, do it.

---

Request for Question Clarification by wonko-ga on 07 Apr 2004 10:48 PDT

I have drawn the feasible combinations, but I cannot determine how the
individual will maximize their utility without their indifference
curves.  With the indifference curves, one can derive the demand
curves.

---

Clarification of Question by linked2net-ga on 07 Apr 2004 10:57 PDT

This was all the information I was given for the problem. Insert an
arbitrary indifference curve where ever would seem logical, then show
me an individual maximizing their utility on with respect to that
curve. The budget constraint must be tangent to the indifference
curve.Right? The rest of the questions seem possible if you do this.
Thanks!

First, the graph of feasible combinations:

If the price of X1 is $10, then the most X1 a person with an income of
$250 can purchase is 25 ($250/$10).  So, you plot 25 on the y-axis.

If the price of X2 is eight dollars, then the most X2 a person with an
income of $250 can purchase is 31 ($250/$8 rounded down to the nearest
unit).  So, you plot 31 on the x-axis.

To establish the feasible combinations, you draw a straight line
between 25 on the y-axis and 31 on the x-axis.  Everything below and
to the left of the line is a feasible combination.  The line is called
a budget line.

When the price of X1 decreases to $5, the person can now purchase up
to 50 X1.  So, you plot 50 on the y-axis.  The quantity of X2 that can
be purchase remains unchanged.

To establish the new feasible combinations, you draw a straight line
between 50 on the y-axis and 31 on the x-axis.  Everything below and
to the left of the line is a feasible combination.  You have now
established the new budget line reflecting the reduced price of X1.

In order to determine what combination of X1 and X2 a person will
purchase, you need their indifference curves.

"A line will connect all possible combinations of good A and good B
that show the same level of utility. This line is called an isoutility
(iso is Greek and means "the same" or "equal") line or, more commonly,
an indifference curve."

"Indifference Curves"
http://ingrimayne.saintjoe.edu/econ/MaximizingBeha/Indifference.html
(see web site for graphical examples).

"Looking at two different prices has produced two different points on
an individual's demand curve. By varying the price of good A, other
points could be found and an entire demand curve for one individual
consumer constructed."

http://ingrimayne.saintjoe.edu/econ/MaximizingBeha/DerivingDemand.html
"Deriving Demand" (This web site shows with graphical examples
precisely how the indifference curves would interact with the budget
lines we have drawn to establish which combination of X1 and X2 a
person will purchase to maximize their utility.  The second graph is
especially illustrative
(http://ingrimayne.saintjoe.edu/econ/MaximizingBeha/Figure8.4.gif).)

By listing the price and quantity combinations that arise from
shifting the price of X1 and plotting them on a graph, you will have
generated the demand curve for X1.  You can do the same for X2.

Sincerely,

Wonko