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Question 1: Assume that there are two goods. The price of the first good is $4 and the price of the second good is $10. The income is m=200.

• Determine the budget constraint.
• Determine the slope and the intercepts of the budget line.
• Graph the budget set.
• Assume that income increases to m=300. At the same time the price of good 1 increases to 10. Determine the equation of the new budget line.
• Determine the slope and the intercepts of the new budget line.
• Graph the new budget set.

Question 2: Assume that the prices of three goods are given by p₁=2, p₂=4 and p₃=10. A consumer has an income of 49 Dollars. Assume that he/she wants to purchase 2 units of good 1 and twice as many units of good 2 than of good 3. How many units of each good can he/she afford (given our standard assumption that the consumer is not restricted to purchasing whole units)?

Question 3: Assume that a store offers a discount for cereals. That is, if you buy three boxes for $2 each, you can buy any additional box for $1. In the following assume you graph the amount of cereal on the horizontal and all other goods (as a composite good) on the vertical axis. The price of one unit of the composite good is of course 1. Also for simplicity, that cereal is perfectly divisible (i.e., does not have to be consumed in whole units). The income is m=20.

• Find the vertical intercept of the budget line (i.e., the consumption bundle on the budget line for which x₁=0).
• Find the point on the budget line where the price changes (i.e., the consumption bundle on the budget line for which x₁=3).
• Find the horizontal intercept of the budget line (i.e., the consumption bundle on the budget line for which x₂=0).
• Graph the budget set.
• Determine the slope of the budget line if x₁=<3 and the slope if x₁>=;3.

Question 4: Assume that a health insurance covers 80% the cost of a particular drug up to $1,000. Any additional expenditure is not covered. Assume that the price of 1 unit of the drug is $100. The consumer's income is $2,000. Similar to the previous question, graph the quantity of the drug on the horizontal and all other goods (as a composite good with price 1) on the vertical axis. Again assume that the drug is perfectly divisible.

• Find the vertical intercept of the consumer's budget line (i.e., the consumption bundle on the budget line for which x₁=0).
• For what value of x₁ does the effective price faced by the consumer change?
• Find the corresponding value of x₂ such that the consumption bundle (x₁,x₂) is on the budget line.
• Find the horizontal intercept of the budget line (i.e., the consumption bundle on the budget line for which x₂=0).
• Graph the budget set.
• Determine the slopes of the budget line.
• Now assume that a consumer can only get a prescription for 10 units of the drug. Thus, x₁=<10. Draw the new budget set (Note: This is situation with rationing).

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