1. Suppose Mary has an income of $80 to buy bags and belts. The price of a belt (good 1) is $10 and the price of a bag (good 2) is $20.

1) Derive the intercept-slope equation of Mary’s budget line.

2) Graph her budget line. As always, label the axes and identify the intercepts and slope.

3) What is the opportunity cost of a belt? Interpret.

4) The price of a belt doubles and that of a bag halved. Also, income is halved. What happens to the opportunity cost of good 1?

5) Suppose Mary spends the entire $80. How many bags can she buy if she decides to have four belts?

6) Suppose a reduced price for belts, from $10 to $8. What effect would this have on Mary’s budget line? What is the effect on the opportunity cost of a belt?

7) Let us consider the effect of rationing on belts. This means that the maximum number of belts Mary can buy is five. Graph her budget line and explain the effect of rationing.

2. Martha, Mary’s sister, also buys belts and bags. Her consumption behavior is such that she can buy two belts (good 1) and three bags (good 2) or six belts and one bag.

1) What is the opportunity cost of a belt?

2) Derive the expression for her budget line, in intercept-slope form.