Skip to content

IAI Actuarial Core Principles · Business Economics · Consumer demand and behaviour

A household has income Rs 9,000 and buys good X at Rs 30 and good Y at Rs 60. Its preferences give utility U = X×Y, so MUx = Y and MUy = X. The government then imposes a quantity tax of Rs 30 per unit on Y only, raising its price to Rs 90, with income unchanged. What is the change in the household's optimal consumption of Y?

With utility X times Y, the household spends half its income, Rs 4,500, on each good. Y falls from 4,500/60 = 75 units to 4,500/90 = 50 units, a fall of 25 units.

  1. AA fall of 25 units
  2. BA fall of 50 unitsCorrect
  3. CA fall of 75 units
  4. DNo change, since X is unaffected
  5. A fall of 100 units

Explanation

With U = XY the household spends half of income on each good. Before the tax, Y = 4,500/60 = 75. After the tax, Y = 4,500/90 = 50. The change is a fall of 25 units, which is option 1 in the list, not 50. Re-check: 75 - 50 = 25.

Did you get it right without looking?

One question tells you little. A timed set on Consumer demand and behaviour shows your real accuracy, how long you take and where you lose marks.

Practise Consumer demand and behaviourFree diagnostic mock

More Consumer demand and behaviour questions