# Short Assignment 3 Answer Key - ECON 256 Intermediate...

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ECON 256: Intermediate Microeconomics Short Assignment: 3 1 Answer Key Due Date: Thursday, October 28, 2010 1. (a) The following graph shows John’s budget constraints and indifference curves with respect to two goods: fresh-cut flower and candy bars. John spends \$150 on these two goods. Initially the price of a flower bunch is \$10 and a 5-lbs bag of candy bars is \$10. Label this initial budget constraint in the graph as BC 0 . And label John’s initial optimal consumption bundle as X. Now due to a shortage in world sugar supply, the price of candy bars go up and the new price of a 5-lbs bag of candy bars is \$30. Label the new budget constraint in the graph as BC 1 . And label John’s new optimal consumption bundle as Y. Note that all the relevant consumption bundles are already identified in the graph; you only need to label which one is X and which is Y . You can label the remaining identified consumption bundle as Z. (b) Now labeling the Hicksian budget constraint (BC H ) in the graph, clearly identify in the graph and describe in words below the total, substitution, and income effects of the price increase in candy bars. To show the effects graphically, you can draw vertical lines from the consumption bundles and then show the three effects.

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ECON 256: Intermediate Microeconomics Short Assignment: 3 2 Total effect: X (4, 11) to Y (2, 9) Substitution effect: X (4, 11) to Z (1.5, 15) Income effect: Z (1.5, 15) to Y (2, 9) (c) How much change (increase/ decrease – underline one) in income is equivalent to the income effect on the price increase in candy bars? _ \$45 ___ (d) From your analysis above, can you say whether candy bar is a normal or inferior good? Explain your answer.
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Short Assignment 3 Answer Key - ECON 256 Intermediate...

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