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A Budget Constraint - Assignment Example

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In the paper “A Budget Constraint” the author provides the case where a customer will sometimes buy one bundle of goods even if she prefers another for various reasons. The consumer is faced with a budget constraint. The consumer is will choose that bundle which maximizes utility…
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A Budget Constraint
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Download file to see previous pages Therefore, the customer may prefer a combination that is outside of his budget say on IC3 or outside of his budget, however, right now that preference is unattainable.
2. (a)If interest rate in the UK are forecast to rise during 2011 then individuals would increase there savings and cut back on consumption. There is a positive relationship between the interest rate and savings. This will result in an increase in the amount of funds available for loans. There is a negative relationship between interest rate and borrowing. As interest rate increases the demand for loans decreases,
(b) The lender will benefit more from increases in interest rate. According to Varian (1999 p186 - 187): “If a person is a lender and the interest rate rises, he or she will remain a lender. … A borrower is made wore off by an increase in the interest rate. When the interest rate facing a borrower increases and the consumer choose to remain a borrower, he or she is certainly worse off.” The reason is that for the borrower an increase in interest rate simply means he will have to pay more interest in period 2. The substitution effect causes the borrower to borrow less and therefore consume less in period 1. So whatever the borrower does he ends up being worse off.
3. (a) When there are only two firms in an industry there is a duopoly. Assuming that firm which produces at the same constant marginal cost, but with zero fixed cost i.e, they share the same cost conditions then on price this may result in a price war. When firm A reduces price this will elicit a response by Firm B. This response will affect the sales of Firm A which is then forced to respond to prevent this situation which obviously will affect profits. If the Bertrand model (non-cooperative duopoly model) is followed the firms will independently set their prices. Consumers will respond by purchasing from the firm with the lowest price.  ...Download file to see next pagesRead More
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