MB 515: Economic Theory and Application Show all working to receive full points Problem Set 2 2.1 Suppose a consumer has the indifference map shown below. The relevant budget line 15 LZ. The price of good 1s $200. oA S Y Quantity of What 15 the consumer's income? What 15 the price of X7 Write the equation for the budget line LZ, What combination of X and will the consumer choose? Why? What 1s the marginal rate of substitution at this combination? Explain in terms of the MRS why the consumer would not choose combinations designated by A or B. Suppose the budget line pivots to LM, income remaimng constant. What 1s the new price of X? What combination of X and 1s now chosen? What 1s the new MRS? 2.2 a. After reading the assigned CNBC and NYTimes/Reuters article readings, briefly summarize their main points. b. After going through the assigned Case Study Reading, draw an intertemporal budget constraint where the consumer chooses between consumption teday, Ci, and consumption in the future, Ca. On this same space, draw a utility maximizing indifference curve of your choice and state whether the consumer is a saver or borrower in your diagram. . In a different diagram, redraw the intertemporal budget constraint and an indifference curve that maximizes utility give the constraint. Assuming interest rates rise, draw a new budget constraint that has pivot at the point where present income Y; equals future income Yz. Then draw a new utility maximizing indifference curve for this new budget constraint at a point where the income effect would be negative. Draw a temporary budget line parallel to the post-pivot budget line but tangential to the pre-pivot indifference curve. Use it to identify the substitution effect and income effect. (Hint: Reverse the visual analysis in the Case Study Reading, which explains a fall in interest rates) d. Based on your diagram, is household debt a normal or inferior good? e. Would managers of a firm whose customers use debt financing to purchase its products recommend inventory/stock increases or decreases if rates rise