ECON 212

Chapter 2 Practice Questions

Fall 2024

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Ibi 1. Julia consumes apples and oranges (these are the only fruits she eats). She has decided that her
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monthly budget for fruit will be $100. Suppose that one apple costs $0.5, while one orange costs
$1. Let x denote the quantity of apples, and y denote the quantity of oranges that Julia purchases.

ˋ 六 (a) What is the expression for Julia’s budget constraint? 0.5x y 100
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(b) Draw a graph of Julia’s budget line.
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(c) Show graphically how Julia’s budget line changes if the price of apples increases to $1.
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(d) Show graphically how Julia’s budget line changes if the price of oranges decreases to $0.5.
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(e) Suppose Julia decides to cut her monthly budget for fruit in half. Coincidentally, the next time
she goes to the grocery store, she learns that oranges and apples are on sale for half price and will
remain so for the next month, i.e., the price of apples falls from $0.5 per apple to $0.25 per apple,
and the price of oranges falls from $1 per orange to $0.5 per orange. What happens to the graph
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of Julia’s budget line?
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2. Ann consumes only cereal and milk for her breakfast. If she spent all her breakfast budget, she
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could buy two boxes of cereal and three bottles of milk, or she could buy four boxes of cereal and
two bottles of milk. The price of milk is $5 per bottle.

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(a) What is Ann’s breakfast budget?

(b) On a graph, draw Ann’s breakfast budget line. Remember to label your axes and the two
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intercepts.
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(c) Now suppose that the government will impose a quantity subsidy policy on cereal so that

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consumers can get $0.5 for each box of cereal they purchase. The price of milk remains the same,
and so does Ann’s breakfast budget. What is Ann’s new breakfast budget line? Draw this line on
the same graph as in (b). Remember to distinguish your lines. 2 ㄨ 5y 20 y
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(d) Now suppose loses5y
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her job, so her breakfast budget will only be half the amount in
(a). The prices of cereal and milk do not change. What is her new breakfast budget line? Draw
this line on the same graph as in (b). Remember to distinguish your lines. linwaHTshiftofocsrisin.at
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(e) Now suppose that cereal becomes the numeraire good. Also, assume that Ann’s breakfast budget
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is returned to its original value as in (b). What is the relative price of milk now? What is Ann’s
relative breakfast budget? Write down her budget line in this case. Is it di↵erent from her budget
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3. Chloe has T hours to divide between labor and leisure. She can earn $W for each hour she
works.

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(a) On a graph, carefully draw and label Chloe’s income-leisure budget constraint with leisure hours

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being on the X-axis and income on the Y-axis. ⼆
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(b) Suppose the government o↵ers a 20% wage subsidy. On a graph, draw and label Chloe’s new
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budget curve, as well as her budget curve from (a). miiei9，4

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(c) Suppose the government introduces a universal basic income where all individuals receive $5,000
in addition to income they receive from working. On a graph, draw and label Chloe’s new budget
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curve, as well as her budget curve from (a).

(d*) Suppose a new policy called the Earned Income Tax Credit (EITC) is introduced and designed

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so that low-wage workers receive additional income from the federal government depending on how
much they earned and how many children they have. If Chloe has one child, then

• there is no credit if she earned nothing;

• the credit equals $0.50 per dollar earned and peaks at $4,000 when she earned $8,000;

• it remains at $4,000 until she earned $16,000;

• it is phased out gradually, by $0.25 per dollar earned, until eliminated completely if she earned
$32,000 or more per year.

On a graph, draw and label Chloe’s new budget curve under the EITC, as well as her budget curve
from (a).

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 ECON 212
Chapter 2 Practice Questions
Solutions

Fall 2024

1.

(a) Julia’s budget constraint: 0.5x + y  100

(b) Panel (a) in Figure 1 shows Julia’s budget line. Note that the slope of the budget line is -1/2.
1 the slope of the budget line changes from -1/2 to -1. So,
(c) If the price of apples increases to $1,

0
the budget line becomes steeper (red line), as shown in panel (b) of Figure 1. Also, note that the
horizontal intercept decreases from 200 to 100 when apples become more expensive.

(d) If the price of oranges decreases to $0.5, the slope of the budget line changes from -1/2 to -1.
So, the budget line becomes steeper (red line), as shown in panel (c) of Figure 1. Also, note that
the vertical intercept increases from 100 to 200 when oranges become cheaper.

(e) Julia’s budget line would not change.

1/2⇥100
! Horizontal intercept of the budget line: 1/2⇥0.5 = 200
1/2⇥100
! Vertical intercept of the budget line: 1/2⇥1 = 100
1/2⇥0.5
! Slope of the budget line: 1/2⇥1 = 1/2

The slope and horizontal and vertical intercepts are the same as before; thus, the budget line does
not change.

2.

(a) Let p1 denote the price of cereal per box. Then it must satisfy

2p1 + 3 ⇥ 5 = 4p1 + 2 ⇥ 5. (1)

So p1 = 2.5. Then Ann’s breakfast budget is 2 ⇥ 2.5 + 3 ⇥ 5 = 20.

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 Figure 1: Julia’s Budget Lines

(a) (b)

(c)

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(b) Let x1 denote the amount of cereal and x2 denote the amount of milk. Then Ann’s
budget line is given by
2.5x1 + 5x2 = 20 or x2 = 4 0.5x1 . (2)
Her budget line is shown in Figure 2 as the black line.

(c) Ann’s new budget line is given by

(2.5 0.5)x1 + 5x2 = 20 or x2 = 4 0.4x1 . (3)

Her new budget line is shown in Figure 2 as the blue line.

(d) Her new budget line is given by

2.5x1 + 5x2 = 10 or x2 = 2 0.5x1 . (4)

Her budget line in this case is shown in Figure 2 as the red line.

(e) The relative price of milk is $5/2.5 = 2. Her relative breakfast budget is $20/2.5 = 8. Her
budget line in this case is given by
x1 + 2x2 = 8. (5)
It is the same as her budget line in (b).

Figure 2: Ann’s Budget Lines

milk

0 4 8 10 cereal

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3.

(a) Let x be Chloe’s leisure hours and y be her income. Her budget constraint can be written as:

y  (T x)W i.e. y  T W W x and x  T. (6)

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This budget curve is shown in Figure 3 (a) as the black line. ㄅ iwnwx

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(b) Chloe’s new budget constraint can be written as:

y  (T x)(1 + 0.2)W i.e. y  1.2T W 1.2W x and x  T. (7)

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This new budget curve is shown in Figure 3 (b) as the blue line.

(c) Chloe’s new budget constraint can be written as: Y IT X W 5000 Y Tw 5000_wx
y  (T x)W + 5000 i.e. y  T W + 5000 W x and x  T. (8)

This new budget curve is shown in Figure 3 (c) as the red curve.

(d) Chloe’s earned income is W (T x) if she works (T x) hours.

• When Chloe earned nothing, x = T and y = 0;

• When she earned between 0 and 8000, i.e. 0  W (T x)  8000, the credit is 0.5W (T x).
So her budget is y = W (T x) + 0.5W (T x) = 1.5W (T x) for x 2 [T 8000/W, T ];
• When she earned between 8000 and 16000, i.e. 8000  W (T x)  16000, the credit is 4000.
So her budget is y = W (T x) + 4000 for x 2 [T 16000/W, T 8000/W ];

• When she earned between 16000 and 32000, i.e. 16000  W (T x)  32000, the credit is
4000 0.25W (T x 16000/W ). So her budget is y = W (T x) + 4000 0.25W (T x
16000/W ) = 0.75W (T x) + 8000;
• When she earned above 32000, i.e. 32000  W (T x), there’s no more credit. So her budget
is just y = W (T x).

Therefore, her budget curve under the EITC can be drawn as the green curve in Figure 3 (d).

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 Figure 3: Chloe’s Budget Constraints

income income

1.2T W

TW TW

0 T leisure 0 T leisure
(a) (b)

income income

T W + 5000
TW TW

32000

20000
16000
12000
8000
5000

0 T leisure 0 T leisure
(c) (d)