Income Elasticity of Demand


ECO 305 Problem set 2

  • Suppose a consumer had an income of $100 and spends $50 on potatoes. Suppose now that his income goes up to $150, and his spending on potatoes goes up to $100. No prices have changed (so the quantity of potatoes purchased doubled). Compute the consumer’s income elasticity for potatoes.
  • Suppose a consumer has an income of $100. P1=10 and p2=10.
    • Draw the consumer’s budget constraint
    • On the same drawing, add an indifference curve on which the optimal basket lies. Assume the indifference curve is convex as usual
    • On the same drawing, add an indifference curve which has a lower utility level than the optimal basket. Make sure to include the intersections of the curve with the budget constraint, and carefully explain why they cannot be optimal although they are on the budget line.
  • Suppose the two goods, X1 and X2, are perfect substitutes at the ratio of 1 to 2 – each unit of X1 is worth, to the consumer, 2 units of X2. The consumer had an income of $100. P1=5, and P2=3. Find the optimal basket of this consumer.
  • Suppose we have two consumers in the market. Joe has the following demand curve: P=10-Q1. Lucy has the following demand curve: P=10-3Q2. Find (algebraically) the formula for the market (or aggregate) demand curve. Draw all 3 curves on 3 separate graphs that should be drawn next to each other (so I can see the horizontal summation of quantities).
  • Suppose the two goods, are perfect complements at the ratio of 1 to 1. P1=10 and P2=40. I=1000. Find the optimal basket for this consumer, and graph it (including the budget line and the relevant indifference curve)

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