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    ECO206 Problem Set 1 Questions Budget Constraints

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    ECO206 Problem Set 1 Questions Budget Constraints

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    ECO206 Problem Set 1 Questions Budget Constraints

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    ECO 206Y1Y: Microeconomic Theory Prof.

    Freitas, University of Toronto

    Problem set 1: Budget Constraints


    Questions

    1) A consumer spends their income of $100 on two goods–mangoes and oranges. Mangoes are $10
    a kilo for the first 5 kilos and then $5 a kilo after. Oranges are $2 a kilo.

    (a) What is the Opportunity Cost of an extra kilo of mangoes?


    (b) Draw the consumer’s budget line (kilos of oranges on the x-axis and kilos of mangoes
    on the y-axis) and indicate how it will change when
    (i) the price of mangoes increases by $1 for the first 5 kilos.
    (ii) consumer income increases by $10.

    2) A consumer is choosing two goods–cookies and popsicles. Their only income is from an endow-
    ment of 10 packs of cookies and 5 packs of popsicles. Cookies are $7 a pack and popsicles
    are $4 a pack.

    (a) What is the Opportunity Cost of an extra pack of popsicles?


    (b) Draw the consumer’s budget line (popsicle packs on the x-axis and cookie packs on the
    y-axis) and indicate how it will change when
    (i) the price of popsicles increases by $4 and the price of cookies increases by $7. Does
    this make sense? Explain the intuition in a few sentence.
    (ii) The price of cookies decreases by $2. Does this make sense? Explain the intuition
    in a few sentence.

    3) Suppose you have two goods to spend your money on - x1 and x2 with prices p1 and p2 . Your
    only income comes from an endowment of 6 units of x1 and 2 units of x2 .

    (a) Write down your budget constraint.


    (b) What is the Opportunity Cost of x2 ?
    (c) Suppose there is fire and you lose 2 units of x1 .How does your budget set change? Why?
    (d) Suppose the government imposes a restriction that says people cannot sell any x2 they
    have. They can only purchase it in the market. How does your budget set change?
    Why?

    4) You are in head of marketing of your student club. You have a budget of $200 and are put
    in charge of printing flyers to hand out on campus. The local print shop has two pricing
    schemes listed below. For each scheme write down a budget constraint.

    202209 1 of 2 Problem Set 1 Questions


    ECO 206Y1Y: Microeconomic Theory Prof. Freitas, University of Toronto

    (a) A flat rate of $0.05 a page


    (b) Each page costs $0.07 per page up to 2000 pages . If you print more than 2000 pages
    every page including the first 2000 pages is $0.03 per page.
    (c) On a clearly labeled graph draw both budget constraints. If you had a choice between
    the pricing schemes which one would you choose and why?

    4) Suppose you are on vacation. At the airport, you have to decide between renting a car or
    taking taxis. Once you make your transportation choice, you use only that form of transport
    the entire vacation.
    Renting a car costs $300 and then you pay $0.2 per mile drive. If you take a taxi, you would
    pay $1 per mile driven and no fixed fee.
    For each method of transportation, calculate the opportunity cost of traveling a mile. (Hint:
    think about what you are trading off to travel on your vacation given you have chosen a form
    of transport)

    5) Food stamps are a form of social assistance where people below a certain income level get
    "stamps" than can be exchanged for food worth a certain amount of dollars. Think gift cards
    loaded with a certain amount of money that can only be exchanged for good. Suppose that
    you are the government and have two options:
    1. Restrict the recipient to only use the stamps they have been allocated or
    2. Allow them to exchange them at a government store for the dollar value of the card (i.e.
    convert it into cash)
    On a clearly labeled diagram draw a budget constraint for each option. What option would
    allows for more affordable bundles for the food stamp recipient? Explain your reasoning
    clearly and use diagrams.

    202209 2 of 2 Problem Set 1 Questions

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