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General Background of Organization

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Submitted By cathyyan
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Chapter 4: Answers to Questions and Problems
1. a. The market rate of substitution is
Px Py 10 40 0.25 .

b. See Figure 4-1. c. Increasing income to $800 (by $400) expands the budget set, as shown in Figure 4-1. Since the slope is unchanged, so is the market rate of substitution.
Budget Set
Y 25 20 15 10 5 0 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80

Increase in income

X

Figure 4-1

Managerial Economics and Business Strategy, 5e

Page 1

2. a. The consumer’s budget line is $250 $5 X $10Y . Rearranging terms and solving for Y results in Y 25 0.5 X . b. See in Figure 4-2. c. When the price of X increases to $10, the budget line becomes $250 $10 X $10Y , which is equivalent to Y 25 X (after rearranging and simplifying terms). This is shown in Figure 4-2. The market rate of substitution Px P 5 1 10 changes from to x 1. Py Py 10 2 10
Budget Set
Y 30 25 20 15 10 5 0 0 5 10 15 20 25 30 35 40 45 50 X

Figure 4-2 3. a. Since the slope of the line through point A is

20 20

1 and the price of good X

is $5, it follows that Py

5.

b. If the consumer spends all her income on good X she can purchase 20 units. Since these units cost $5 each, her income must be $100. c. At point A, the consumer spends ($5)(10) = $50 on good Y, which means that the remaining $100 - $50 = $50 is being spent on good X. Since good X costs $5 per unit, point A corresponds to 10 units of good X. d. The price of good Y decreased to $2.50. The consumer achieves a higher level of satisfaction at point B. 4. This is not always the case. For instance, if the consumer was initially consuming more of the inferior good than a gift certificate would purchase, then less of the inferior good will be consumed when given a gift certificate.
Michael R. Baye

Page 2

5.

A half-price sale cuts the price of each and every unit in half. In contrast, a buy-one, get-one-free deal does not change the relative

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