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Date Submitted: 09/25/2012 05:22 AM

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Option 1 a

A basic assumption in traditional economics is that utility increases with the consumption of more goods and services, the concept mostly commonly known as “more is better” this concept explains that all else equal, a person prefers more consumption to less. However their consumption may not always be what they prefer, they may be restricted in their preferences due to resource constraints such as time and money, money being the most prevalent constraint. This gives rise to the notion that happiness is positively related to income.

The notion that income is positively related to happiness, is this true? This notion suggests that as ones income level increases, so too does their happiness, as shown in the graph below.

Constraint is the factor by which something is limited. In this case, income. economics seeks to deal with the allocation of scarce resources to the unlimited wants that are present. Income is the scarce resource and in economics this is known as the budget constraint, because consumers have many wants, but are limited by their budget, it limits an individual from achieving a desired utility level. The relative prices of items affect the budget constraints, not the absolute levels. This is to say that if income and prices doubled, the constraints would remain the same, as both doubled, allowing consumers to achieve the same level of consumption with the same amount of scarce resources as before.

Like indifference curves, budget constraints are larger further away from the origin, as such an increase in income results in a parallel right shift in the budget constraint, and a decrease would result in a parallel left shift, as shown below.

If however only the price of the goods increased, and their budget remained the same, the slope of the graph would become steeper, for consumers would not be able to afford the same number of goods as they once could due to the price hike. Income effect is brought about by the change in the...