A. If the prices of all products are rising at 5 percent per year and your emplo

Question

A.        If the prices of all products are rising at 5 percent per year and your employer gives you a 5 percent salary increase, are you better off, worse off, or equally well off in comparison with your situation a year ago? Use indifference curve analysis to explain your answer.

B.        Instead, if the prices of all products are rising at 5 percent per year and your employer gives you a 10 percent salary increase, are you better off, worse off, or equally well off in comparison with your salary a year ago? Use indifference curve analysis to explain your answer.

Explanation / Answer

A) Here is this case ,
Let us say P1= 50 and S1 =100
Ratio between P1 : S1 = 1/2
Again, after 5 % increment ,
P2 = 50+ 50*0.05 = 52.5 and S2 = 100 + 100* 0.05 = 105
Again , the ratio is P2/S2 = 52.5/105 = 1/2
So, the salary increase and price of commodity increase shifts the indifference curve upwards but since the ratio are same so the individual is equally well off.

B) Now, here is this case ,

From above we have P1/S1 = 1/2
And P2 = 50+ 0.05 * 50 = 52.5
S2 = 100 + 100 * .1 = 110
So, P2/S2 = 52.5 / 110 = 0.477

So, here salary increase is more as compared to price. The indifference curve shifts more towards salary side.

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