With Some Services, E

question 75

Essay

With some services, e.g., checking accounts, phone service, or pay TV, a consumer is offered a choice of two or more payment plans. One can either pay a high entry fee and get a low price per unit of service or pay a low entry fee and a high price per unit of service. Suppose you have an income of $100. There are two plans. Plan A has an entry fee of $20 with a price of $2 per unit. Plan B has an entry fee of $40 with a price of $1 per unit for using the service. Let x be expenditure on other goods and y be consumption of the service.
a. Write down the budget equation that you would have after you paid the entry fee for each of the two plans.
b. If your utility function is xy, how much y would you choose in each case?
c. Which plan would you prefer? Explain.

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Definitions:

Compounded Annually

Interest calculation on the principal and the accumulated interest once a year.

Annual Payments

Payments made once every year towards a debt or investment.

Future Value

The value of an asset or sum of money at a specific future date, calculated by applying expected rates of growth or interest.

Compounded Monthly

Interest calculation method where the interest is added to the principal each month, and the total becomes the principal for the next calculation.