Part A (40% of the marks)
Maya can afford a monthly budget of £200 for treats and electricity. Assume that both are normal goods.
Suppose that the prices are £20 per unit for electricity and £10 per treat. Draw a diagram showing Maya’s budget constraint and feasible consumption set. Explain your answer. Your diagram should measure number of treats along the horizontal axis and number of units of electricity along the vertical axis. (8 marks)
Reproduce your diagram for Question 1 and add an indifference map comprising at least three indifference curves. Show the point of Maya’s utility maximization given her monthly budget and the prices of electricity and treats. Explain why this is a unique point. (10 marks)
Now suppose that Maya’s income increases such that she can afford a monthly budget of £300 for electricity and treats. Reproduce your diagram for Question 2 and show how the increase in her budget changes her point of utility maximisation. Explain your answer. (10 marks)
Finally, suppose that the price of electricity falls to £10 per unit whilst the price of treats is unchanged. Reproduce your diagram for Question 3 and show the effect of the price change on her point of utility maximisation. Make sure you illustrate and explain both the substitution effect and the income effect. (12 marks)
