Budget constraints + Optimal choice

Question 1

Illustrate the impact of a reduction in the P of good Y on the BC

Answer 1

Pivots outwards

Question 2

Define an interior solution

Answer 2

Reflect optimal Q that are positive for both goods, X* > 0 and Y* > 0

Question 3

What is the tangency condition?

Answer 3

MRS = MRT = -Px/Py = -MUx/MUy

Question 4

Linear BC formula?

Answer 4

PxX + PyY <= M

Question 5

How to calculate the optimal choice?

Answer 5

1) Find the optimal ratio of the 2 goods (MRS = MRT in its simplest form to just variables X and Y)
2) Insert the OR into the BC (<= turns into =)

Question 6

What does it mean if the optimal ratio is 4Y* = X*?

Answer 6

The consumer will always optimally choose 4 units of X for every unit of Y

Question 7

What is a corner solution?

Answer 7

The optimal quantity of one of the goods is 0 (occurs when MRS is either > or < than MRT)