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Ch 3 Practice Questions
1. Suppose Peggy consumes only two goods, gasoline and cigarettes. Her income is $120, the price
of cigarettes per pack is $4 and the price of gasoline per gallon is $2. Currently, she consumes 40
gallons of gas.
Sketch the following budget lines. (Put gas on the X axis.) Be sure to show how you calculated the
slopes and end points.
A. Graph this budget line first, before doing each of the following. Using an arbitrary convex
indifference curve, indicate the current consumption combination is optimal. How many
packs of cigarettes does she consume?
B. If the government imposes a sales tax of $1 per unit on gasoline, Peggy will consume 28 gallons
of gas.
C. What happens to the budget line if the $1 tax applies only to purchases of gasoline in excess of
20 gallons? (Do not put an indifference curve for this problem)
D. In addition to the above prices (no tax) and income, Peggy is given 10 packs of cigarettes, which
she cannot sell. (Do not put an indifference curve for this problem)
E. What happens if instead Peggy can sell the 10 packs at $4? (Do not put an indifference curve for
this problem)
2. Given Mary’s current consumption of beer and French fries, her MRS of beer is 3 bags of French
fries. The market price of French fries per bag is $1 and the market price of beer per bottle is $2.
a. Graph the budget constraint below putting beer on the horizontal axis. What is the slope of
the budget constraint?
b. On the same graph, draw in the current indifference curve and indicate the current
consumption bundle.
c. Can Mary be made better off by consuming a different quantity of beer and French fries than
she is consuming now? Explain how if she can.
3. a. Assume Jessie consumes Lettuce (PL = 4) and Tomatoes (PT = 3) and has an income of $180. Graph
Jessie’s budget constraint below putting Tomatoes on the horizontal axis. What is the slope of the budget
constraint and what economic relevance does it have for Jessie?
b. On the same graph, draw in Jessie’s current indifference curve assuming for her current bundle, the
MRS = 1.5. Using the MRS and the price ratio, explain whether Jessie is currently maximizing utility. If
she is not, explain her decision rule for determining whether she should change her consumption.
4. Suppose the marginal value of bread in terms of wine is 1/2 bottle of wine per loaf of bread, while the
relative price of bread in terms of wine is 1/4 bottle of wine per loaf of bread.
(a) Graph the budget constraint below putting bread on the horizontal axis. What is the slope of the
budget constraint?
(b) On the same graph, draw in the current indifference curve and indicate the current consumption
bundle.
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